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An Economic Analysis of the Duty to
Disclose Information: Lessons Learned
From the Caveat Emptor Doctrine
ALEX M. JOHNSON, JR.*
TABLE OF CONTENTS
1.
II.
THE ECONOMIC THEORIES REGARDING DISCLOSURE OF INFORMATION ................ 86
CAVEAT EMPTOR: A COMMON LAW DOCTRINE GONE AWRY-FOR
G OOD AND EFFICIENT REASONS ......................................................................... 100
A.
B.
C.
III.
The Com m on Law Baseline .....................................................................
101
The Erosion of the Doctrine-the Beginning of
Efficient Mandatory DisclosureRules .....................................................
104
Caveat Emptor Light-ProvidingSafe Harborsfor Sellers ..................... 111
CAVEAT EMPTOR LIGHT-
A.
B.
AN ECONOMIC ANALYSIS ......................................... 116
The Development of Mandatory Disclosure Rules: The
New Safe H arbor.....................................................................................
The Reemergence of Silence, The Return of Caveat Emptor....................
119
123
*
Perre Bowen Professor of Law, University of Virginia School of Law. The
genesis of this Article began almost twenty years ago when I first read Professor Carol
M. Rose's article, Crystals and Mud in Property Law, 40 STAN. L. REV. 577 (1988).
Since that time, I have worked on this Article in fits and starts, time permitting, given my
other duties, most recently Dean at the University of Minnesota Law School. As such,
many-too many to name them all-research assistants have worked with me in
finalizing this Article. Most prominent among them is my research assistant during the
1997-1998 academic year, Matthew Rinka. This Article benefited as well from
comments received from attendees at the 2006 Canadian Law and Economics Annual
Conference, where this Article was presented.
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IV.
FROM CRYSTALS TO MUD TO CRYSTALS: THE IMPACT OF
TECHNOLOGY AND C HANGE .........................................................
125
V.
C O NCLU SION ......................................................
132
Several leading law scholars have attempted to explain why certain
legal rules require a party to disclose information to the other contracting
parties, often competing parties, in certain transactions. Most notably,
Dean Anthony Kronman, in his article, Mistake, Disclosure,
Information, and the Law of Contracts, presents an economic theory
explaining why unilateral mistake is allowed as a defense to preclude
contract formation in some cases, but not others.' As part of his
argument, Dean Kronman discusses when a party has a duty to disclose
information to the other contracting party when the other contracting
party does not ostensibly possess that information.2 The obverse of the
rule mandating disclosure is also discussed-when a party is privileged
to remain silent even though the party possesses relevant information (a3
material fact) that the other contracting party would prefer to know.
Dean Kronman concludes that there is no duty to disclose relevant
information that is a product of deliberate investment, but that one
has a
'4
duty to disclose relevant information that is "casually acquired.
Similarly, Professors Cooter and Ulen in their economic treatise, Law
and Economics, put forth a theory to determine when the disclosure of a
material fact is required from the knower to the knowee. 5 They attempt
to draw a distinction between those facts which they determine are
productive (wealth producing or enhancing), which are not required to
be disclosed between contracting parties, and those facts which are
merely redistributive, which the knower is required to disclose to the
knowee.6 Lastly, in a fascinating book addressing the legal issues and
rights that flow from, and are related to, the phenomenon of "secrecy,"
1.
Anthony T. Kronman, Mistake, Disclosure, Information, and the Law of
Contracts, 7 J. LEGAL
STUD.
1, 1-2 (1978).
2. For a fuller explanation of Dean Kronman's thesis, see infra notes 19-23 and
accompanying text.
3. For ease of discussion, the party possessing knowledge of the material fact will
hereafter be referred to as the knower and the party to whom the fact will either be
disclosed or not, depending upon the rule and the allocation of duty, will hereafter be
referred to as the knowee.
4. Kronman, supra note 1, at 13-14. For further discussion, see infra notes 1928 and accompanying text.
5. ROBERT COOTER & THOMAS ULEN, LAW AND ECONOMICS 281-86 (4th ed.
2004).
6. For a fuller explanation of Cooter and Ulen's thesis, see infra notes 31, 33-35,
100 and accompanying text.
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Professor Scheppele theorizes that one party to a contract is privileged to
keep a secret premised on the relative cost of each party's access to the
material fact or relevant information. 7 Briefly, Professor Scheppele's
disclosure theory mandates disclosure of secret information if the
marginal cost of that information is much less for one party to the
contract than for the other party to the contract.8
Although most of these theories have been articulated to explain why
disclosure is or is not required in certain contracting situations having to
do with the sale of personalty, it is clear that these theories, if correct,
must also apply to contracting situations involving the sale of realty.
That is, when the vendor and vendee enter into the contract for the
purchase and sale of real property, they execute a contract that allocates
their respective rights and liabilities. A critical issue at the time of
contract formation has to do with what, if any, facts the vendor-seller
(knower) must disclose to the vendee-buyer (knowee) regarding the
condition of the premises being sold. Enter the doctrine of caveat
emptor, which at common law, in its purest form, provides a safe harbor9
to the vendor-seller not to disclose any information to the vendee-buyer.
KIM LANE SCHEPPELE, LEGAL SECRETS: EQUALITY AND EFFICIENCY IN THE
7.
COMMON LAW 109-26 (1988).
8. Id. In contrast, Scheppele rejects an efficiency explanation and reinterprets the
line of cases similar to Laidlaw v. Organ, 15 U.S. (2 Wheat.) 178 (1817), in terms of an
equal access principle, according to which disclosure is mandatory if the marginal cost of
information is much less for one party to the contract than for the other party. See also
ROBERT COOTER & THOMAS ULEN, LAW AND ECONOMICS 260 n.8 (1st ed. 1988);
SCHEPPELE, supra note 7, at 112-24. In Laidlaw, the British blockaded the port of New
Orleans during the War of 1812, which caused the price of exported goods-in this case,
tobacco-to drop. Organ, a purchaser of tobacco, received information before the
market that the war had ended by treaty and purchased tobacco at the depressed blockade
price. When the treaty was made public, the price of tobacco soared. Laidlaw, 15 U.S.
(2 Wheat.) at 183-84. This is the prototypical case involving unilateral mistake; Organ
knew about the treaty but the seller, Laidlaw, did not, and the seller sought to set the
contract aside based on the unilateral mistake in formation. Ultimately the Supreme
Court affirmed the contract. Id. at 195. It is this case that is discussed by Dean Kronman,
Professors Cooter and Ulen, and Professor Scheppele to test their various justifications
for rules requiring the disclosure of information for contracting parties.
9. Although discussed in more detail in Part II, simply put, the common law
doctrine of caveat emptor, or "let the buyer beware," means that in the absence of fraud,
misrepresentation, or active concealment, the seller is under no duty to disclose any
defects-except those latent defects known to create an unreasonable risk of harm to
persons on the premises-in the subject premises to the putative buyer, and the buyer has
a duty to discover such defects upon a reasonable examination of the property. See
ALEX
M. JOHNSON,
JR.,
UNDERSTANDING
MODERN
REAL
§ 2.06(A) (2d ed. 2007).
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ESTATE TRANSACTIONS
Caveat emptor, then, is a huge exception to any doctrine requiring the
disclosure of information from the knower to the knowee.
This Article examines the economic theories that model rules
requiring the disclosure of information between contracting parties in
light of the development and evolution of the doctrine of caveat emptor.
If correct, these theories predicting when information must be disclosed
must account for the common law usurpation of disclosure requirements
in the purchase and sale of realty. In other words, if the economic
analysis is correct, these theories must explain why no disclosure of
information is required with respect to the sale of realty at common law.
The alternative explanation is that the caveat emptor doctrine should not
be applied with respect to the sale of realty-that its use has been
erroneous for centuries. Hence if the theories are accurate, some disclosure is
or should be required with respect to the sale of realty. Conversely, if
the economic theory mandates disclosure of certain information even
with respect to the sale of realty, perhaps the common law doctrine of
caveat emptor is ill-suited to address issues that arise from modem-day
real estate transactions.
Mapping these economic theories on the doctrine of caveat emptor is,
however, not without problems. The doctrine has not remained static
over time. Indeed, although it is fair to say that the common law
doctrine is fairly easy to articulate and apply, the doctrine itself, as
applied by the courts, has become riddled with exceptions and has been
made null and void by certain legislative enactments. Thus, a case can
be made that the rationale for the use of caveat emptor with respect to
the sale of realty may have been appropriate at the time the doctrine was
developed. However, changes in the nature of the property being sold
may have resulted, over time, in the need for information to be disclosed
consistent with the theories discussed above. This requirement of
disclosure of information from seller to buyer in the residential real
estate transaction, expressed as exceptions to the caveat emptor doctrine,
may demonstrate the efficacy of the economic theories put forth to
explain disclosure rules. However, in one final twist, these theories must
also explain why the doctrine of caveat emptor, in a modified form that I
characterize as "caveat emptor light," is now emerging as a result of
court opinions and legislative enactments.
In other words, applying these economic theories to the doctrine may
have power to explicate what is currently a puzzle: Why has the common
law doctrine of caveat emptor been obliterated through exceptions
causing yet another version of caveat emptor-caveat emptor light-to
emerge as a result? Factor in the changing nature of the real estate being
sold (agrarian land to complex residential dwellings) and the stage is set
for a historical analysis of a doctrine that has transformed itself to adapt
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to current transactional norms. Consequently, following a brief primer
on the three economic theories which attempt to explain when disclosure
is or should be required among contracting parties and which would tend
to eliminate or disprove the need for caveat emptor in any real estate
transaction, this Article begins with a historical exegesis of the doctrine
of caveat emptor.' 0
As a result, this Article examines the evolution of the caveat emptor
doctrine from its common law origins to its current status in American
law. In so doing, this historical analysis tests several economic theories
and attempts to analyze the same in light of the doctrine's evolution. By
using economic theory regarding when material facts should be
disclosed, I hope to demonstrate that the original formulation of caveat
emptor at common law was the correct and efficient rule for the parties
at that time. Conversely, I demonstrate that the exceptions which have
become associated with the caveat emptor rule-which have riddled the
rule-represent attempts by the courts to align disclosure requirements
to parties to a transaction which bears little resemblance to the vendorvendee transaction that originated at common law in agrarian England.
What I hope to demonstrate is that caveat emptor in its pristine
common law form is deemed inapposite for the modem residential real
estate transaction, yet perfectly suited for the real estate transactions that
took place as the doctrine was originally developed and applied. It is the
change in the very nature of the real estate transaction that caused the
doctrine of caveat emptor to become inapposite for real estate
transactions. However, the mandatory disclosure of all information from
seller, or knower, to buyer, or knowee, as mandated by courts and laws
focusing on the status of the parties, is also incongruent and inapposite
with the economic theories requiring the disclosure of information. This
is so because these new laws require inefficient disclosure of
information by mandating the disclosure of all information, including
that which is the product of deliberate investment and, relatedly,
information that is equally available to both parties. As a result, and
efficiently, caveat emptor light is emerging, which I will document is
consistent with the economic theories requiring disclosure of
information and correctly establishes the correct duty for disclosure of
information from the knower, or vendor-seller, to the knowee, or
vendee-buyer.
10.
See infra note 43 and accompanying text.
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The evolution of caveat emptor also serves to validate Professor
Rose's theory in her article, Crystals and Mud in Property Law," which
is addressed in the fourth and final part of this Article."2 Professor Rose,
analyzing the evolution of common law through judicial opinions,
hypothesizes that, broadly speaking, judicial opinions often have the
effect of taking what she terms a "crystal" rule-a rule that is easy to
interpret and apply because its contours are certain, like caveat emptorand ultimately transforming it into a "mud" rule-the antithesis of a
crystal rule or a rule that is difficult to interpret and apply because of the
rule's complexity or the fact-related nature of the rule which requires
precise application of certain facts to a rule to produce a predictable
outcome.' 3 In effect, I argue that the courts have done to the caveat
emptor rule exactly what Professor Rose hypothesized. The courts have
taken a simple and easy-to-apply rule and have muddied it to the extent
that treatises and articles are now written regarding its applicability' 4
The evolution of caveat emptor light represents an attempt to transform
what is now a mud rule into a new crystal rule. This process by which
the crystal rule becomes the mud rule and is in the throes of becoming
crystal again is caused by courts' attempts to align the parties' duties to
disclose information in the residential real estate transaction consistent
with their acquisition of information about the residences being sold.
This Article is divided into four parts. Part I briefly summarizes the
existing literature which provides an economic justification determining
when material facts must be disclosed to an opposing party as part of the
contracting process. Part II spends considerably more time analyzing
the common law caveat emptor doctrine and its evolution to its current
status as a doctrine heavily riddled with exceptions and on the verge of
obsolescence. It pays particular attention to the evolution of the doctrine
of caveat emptor by focusing on those exceptions to the doctrine to
demonstrate that the common law doctrine of caveat emptor is premised
on the parties having equal bargaining power and, as theorized by
Professor Scheppele, 5 is based on access to equal information which can
be thwarted by the delivery of erroneous information or the complexity
of the dwelling conveyed. It then contrasts the economic theories in Part
I with the caveat emptor doctrine examined in Part II to expose the
11.
Carol M. Rose, Crystals and Mud in Property Law, 40 STAN. L. REV. 577,
580-83 (1988).
12. The impetus for this Article, in part, is Professor Rose's use of the caveat
emptor doctrine-actually its erosion in modem law-as one of three examples of
crystal rules evolving into mud rules. See infra notes 116-33 and accompanying text.
13.
See Rose, supra note 11, at 580-83.
14. See infra note 120 and accompanying text.
15. See supra note 7 and accompanying text.
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conflict between the economic theories that explain when information
must be disclosed and the evolution of the caveat emptor doctrine.
Part III continues the focus on caveat emptor light and demonstrates
that courts and legislatures are attempting to align the disclosure rules
regarding real property so that they are consistent with the economic
theories regarding optimal disclosure rules postulated by Dean Kronman
and Professors Cooter and Ulen. The problem, however, is the ad hoc
nature of the determinations given the complexity of the property being
transferred and the potential defects that can also arise. The modem
residential dwelling is so complex and full of potential defects that can
affect or impede value that ex post determinations regarding when
disclosures must be made become factually driven rather than driven by
any consistent theory.
Furthermore, the key to the judicial treatment of caveat emptor is the
fact that the determination of breach of the duty of requisite disclosure is
made with judicial hindsight; it is only later-after the sale-that one
can determine whether the disclosure is or should have been required.
Thus, the duty to disclose quickly evolves into the opposite of caveat
emptor-the requirement that a seller make mandatory disclosures of
every fact to the buyer and the safe6 harbor provisions of statutes
detailing which facts must be disclosed.'
Thus, the concluding portion of Part III also traces the reemergence of
caveat emptor, as provided by statutes which allow sellers to once again
make no representation or warranty with respect to the quality of the
premises sold, thereby allowing the seller to sell the property as is. This
new imposition of caveat emptor is accomplished by a shift in the
default rules that has heretofore gone unnoticed, but represents an
important aspect of the17 development of the new rules of caveat emptor,
or caveat emptor light.
16. By delineating which disclosures must be made from seller to buyer, these
statutes make residential real estate transactions homogenous-assume all properties are
similarly situated and that all buyers and sellers possess and request the same
information-and remove the probity of nondisclosure of facts or conditions not covered
by the statutes from any hindsight determination. For further discussion, see infra notes
85-92 and accompanying text.
17. The important shift in the default rule is that at common law, the seller could
remain silent and take advantage of the doctrine of caveat emptor as long as the seller
remained silent. See infra notes 92, 95-100, 112 and accompanying text. Under the
modem formulation of caveat emptor, the seller can remain silent but in so doing must
alert the buyer that the silence has legal consequences-the purchaser buying the
property as is-that the buyer must internalize as part of the sale.
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The fourth and concluding part of the Article returns briefly to the
doctrine of caveat emptor in order to reconcile the apparent conflict
between the economic theories and the doctrine of caveat emptor. I
argue that this apparent conflict disappears when the caveat emptor cases
are viewed through a historical prism in which the sale of real property
is viewed as evolving from a transaction in which certain information is
never produced or acquired because that information is easily accessible
to both parties, to its current "modern" iteration in which deliberate and
casually acquired information is routinely produced. To support my thesis,
and as noted above, I demonstrate that caveat emptor light has emerged
and will continue to develop
8 and solidify in a process eloquently
'
Rose.
Professor
by
described
When coupled with Professor Rose's analysis, the economic theories
on disclosure of information serve as powerful explanatory theories to
make pellucid why the caveat emptor doctrine in its pristine common
law formulation is ill-suited for modern transactions and, as a result, has
become riven with exceptions giving rise to caveat emptor light. Lastly,
I add one observation to Professor Rose's theory that may explain why
crystal rules become mud rules in some areas, but not others. Professor
Rose's theory more likely applies to areas in which the subject area of
the law is also changing or evolving. As technological advances alter,
modify, or redefine that which is the subject or object of the law, the law
must also adapt to internalize the changes that have created new forms of
property subject to old or inapposite rules.
I. THE ECONOMIC THEORIES REGARDING DISCLOSURE
OF INFORMATION
By examining cases involving unilateral mistake and, more particularly,
when a unilaterally mistaken promisor is excused from performing per
the contract when her error is known or should be known to the other
party, Dean Kronman presents a theory of when information possessed
by one contracting party-the knower-must be disclosed to the other
contracting party-the knowee-and, conversely, when nondisclosure is
privileged in the same setting. Dean Kronman first establishes that the
possession of information should be treated by the state as a property
right in order to allow individuals to benefit from the possession of
secret or semi-secret information.
18.
See Rose, supra note 11.
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One effective way of insuring that an individual will benefit from the
possession of information (or anything else for that matter) is to assign him a
property right in the information itself-a right or entitlement to invoke the
coercive machinery of the state in order to exclude others from its use and
enjoyment. The benefits of possession become secure only when the state
transforms the possessor of information into an owner by investing him with a
legally enforceable property right of some sort or other. The assignment of
property rights in information is a familiar feature of our legal system. The
legal protection accorded patented inventions and certain trade secrets are two
obvious examples. 19
Dean Kronman then extends this standard economic theory to
contracting parties and explains that a property right in information is
similarly created when a party possessing material or relevant information is
permitted to enter and enforce contracts without disclosing the information
to the other party. Concomitantly, a duty to disclose information is the
equivalent of a requirement that the information be "publicly shared"
20
and would destroy the legal protection afforded to private property.
From this basic theory of property rights, Kronman draws a distinction
between information that must be disclosed-property in the public
domain and which cannot be held privately-and information that need
not be disclosed to the other contracting party. 2' The latter is deemed
and treated as private property that is protected by society through
enforcement of the contract notwithstanding the nondisclosure and is
premised on an economic justification. The economic justification that
undergirds the theory is that society is better off when investments are
encouraged or made in the creation or production of information that
will subsequently affect investments or investment decisions. More
importantly, the investment that creates the production of information
will be made at a socially desirable level only if that information is
protected by "a legal privilege of nondisclosure [that] is in effect a
property right ....,22
19. Kronman, supra note 1, at 14 (footnotes omitted).
20. Imposing a duty to disclose upon the knowledgeable party deprives him of
a private advantage which the information would otherwise afford. A duty to
disclose is tantamount to a requirement that the benefit of the information be
publicly shared and is thus antithetical to the notion of a property right
which-whatever else it may entail-always requires the legal protection of
private appropriation.
Id. at 15 (footnote omitted).
21. Id.
22. Id. at 2.
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Hence, it is only when investments are made in the acquisition or
production of information that the investor should be awarded the protection
of a property right. Dean Kronman characterizes this information as
deliberately acquired information and contrasts its antimony, casually
acquired information.
In some cases, the individuals who supply information have obtained it by a
deliberate search; in other cases, their information has been acquired casually....
As it is used here, the term "deliberately acquired information" means
information whose acquisition entails costs which would not have been incurred
but for the likelihood, however great, that the information in question would
actually be produced. These costs may include, of course, not only direct search
costs (the cost of examining the corporation's annual statement) but the costs of
developing an initial expertise as well (for example, the cost of attending
business school). If the costs incurred in acquiring the information... would have
been incurred in any case-that is, whether or not the information was
forthcoming-the information may be said to have been casually acquired. The
distinction between deliberately and casually acquired information is a
shorthand way of expressing this economic difference. Although in reality it may
be difficult to determine whether any particular item of information has been
acquired in one way or the other, the distinction between these two types23of
information has-as I hope to show-considerable analytical usefulness.
Relating this theory to the purchase and sale of real property and the
doctrine of caveat emptor, Dean Kronman asserts that, except in one
context involving patent defects, the information possessed by the
typical homeowner and vendor is casually acquired informationinformation that would have been acquired in any event-which should
lead to its disclosure. 24 With respect to patent or obvious defects, Dean
Kronman agrees with the prevailing and almost universally held view
that such defects need not be disclosed. He aligns this nondisclosure
rule with his theory by noting that since the information not disclosed is
patent, its disclosure is unnecessary since the party on whom the
nondisclosure burden would be placed, the vendor-seller, assumes that
From a social point of view, it is desirable that information which reveals a
change in circumstances affecting the relative value of commodities [for
example] reach the market as quickly as possible (or put differently, that the
time between the change itself and its comprehension and assessment be
minimized). If a farmer who would have planted tobacco had he known of the
change plants peanuts instead, he will have to choose between either uprooting
one crop and substituting another (which may be prohibitively expensive and
will in any case be costly), or devoting his land to a nonoptimal use. In either
case, both the individual farmer and society as a whole will be worse off than
if he had planted tobacco to begin with. The sooner information of the change
[in the market] reaches the farmer, the less likely it is that social resources will
be wasted.
Id. at 12 (footnote omitted).
23. Id. (footnotes omitted).
24. Id. at 22-25.
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the other party, the vendee-buyer, is already in possession of that
information given its obviousness. As a result, he states that a legal rule
requiring communication of this sort would needlessly increase transaction
costs, with no corresponding benefit, because
knowledge of a patent
25
defect is "equally available to the parties.
Thus, Dean Kronman agrees with the emerging trend to require the
disclosure of information regarding the status of the property being sold
and the concomitant large-scale erosion of the doctrine of caveat emptor
because the information being disclosed is casually acquired and the
disclosing seller is the "cheapest cost avoider" given the seller's obvious
access to information concerning the quality of the dwelling and any
potential defects.26 In other words, the rule should protect nondisclosure
only if the "seller has made a deliberate investment in acquiring his
knowledge which he would not have made had he known he would be
required to disclose to purchasers of the property any defects he
discovered. 2 7 Discovering termites, for example, would not be the type
of deliberately acquired information that the homeowner would be
privileged to withhold from-not to disclose to-the vendee-purchaser.
To the contrary, this information would have to be disclosed because
it is either casually acquired by the homeowner-seller during the course
of living in the residence or, even if it is the product of a deliberate
investment, such as hiring a termite inspector to search for latent termite
infestation, it is an investment that the homeowner-seller would make in
any event to protect his investment in the property. In other words, even
if it were the product of a deliberate investment, a disclosure requirement
would not likely reduce the production of such information in the future.
Hence, there is no societal incentive to privilege that informationprotect it as property-when the information regarding the existence of
termites is initially possessed solely by the homeowner-seller.
To sum up, Dean Kronman's theory, as it pertains to the sale of real
property, states that the information possessed by typical homeowners
selling their house is casually acquired information or, if the product of
investment, is information that would have been acquired in any event
which should lead to its disclosure. The only exception relates to patent
or obvious defects in the property being sold.
25.
26.
27.
Id. at 23.
Id.
Id. at 25.
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Assuming arguendo that Dean Kronman is correct, it does not explain
why the common law rule was and is to the contrary. In other words, the
below,2 8
doctrine of caveat emptor, which is discussed in detail
establishes the exact opposite rule-that the seller has no duty to
disclose any information to the buyer, and it is the buyers of the realty
who must conduct their own inspection and assume the risk of loss
caused by any latent defects if they decide to purchase.' 9
Of course, as noted below, the modem doctrine of caveat emptor is
riddled with exceptions and is on the decline. 30 Hence, one could make
the argument that the doctrine in its original formulation was improperly
applied to the sale of real property and should no longer be applied to the
sale of realty. Although this flies in the face of historical reality, one can
defend the erosion of the doctrine of caveat emptor and, relatedly, the
lack of duty imposed on the seller to disclose patent defects, as positive
developments from an efficiency or economic standpoint, because when
the seller is forced to disclose information that is casually acquired, the
disclosing seller is the cheapest cost avoider. In addition, and perhaps
just as importantly, such a disclosure requirement with respect to the
condition of the realty being sold would not likely reduce the production
of such information in the future.
As noted above, there are two additional theories which attempt to
determine and explain when disclosure is or should be required by and
between contracting parties. Professor Scheppele's theory, expressed in
her book and discussed in an earlier edition of Cooter and Ulen's
treatise, is premised on an equal access principle. 31 As I understand it,
Professor Scheppele believes that disclosure should be mandatory if the
production costs or the marginal cost of information is much less for one
party to the contract than it is for the other party. Thus, Professor
Scheppele's theory puts the burden for the acquisition and disclosure of
information on the person with the most effective or efficient access to
the information and reduces or eliminates costs that could inhibit or
increase the cost of the transaction thereby precluding or impeding same.
Pursuant to this theory, akin to Dean Kronman's theory, the selling
homeowner and occupier of the house being sold has easier and greater
access to the condition of the premises sold than the vendee-buyer of the
28.
29.
See infra notes 59-62 and accompanying text.
Compare, however, latent defects that are dangerous, that is they represent a
serious risk of harm to the purchaser or visitors to the property and are known to the
seller. These latent defects that are dangerous and known to the seller must be disclosed
to the buyer. This represents the only exception in the common law doctrine of caveat
emptor. See JOHNSON, supra note 9, § 2.06(B)(1).
30. See infra notes 63-83 and accompanying text.
31. SCHEPPELE, supra note 7, at 109-26; COOTER & ULEN, supra note 8, at 260 n.8.
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house. Consequently, the vendor-seller would have the duty to disclose
material information to the vendee-buyer. The only exception, again,
would be with respect to patent defects. Since those defects are by
definition obvious and apparent to both parties, the seller no longer has
better or easier access to the information regarding this particular defect
and, correspondingly, no duty to disclose it. As addressed below, applying
this theory to the sale of real estate results in the large-scale eradication
of the doctrine of caveat emptor and raises new questions regarding its
efficacy with respect to the sale of real property.32
The third and last theory to address the efficient production of
information from one contracting party, the knower, to the other, the
knowee, is that elaborated by Professors Cooter and Ulen in their
exceptional treatise, Law and Economics. 33 Professors Cooter and Ulen
base their theory on the distinction between so-called productive versus
redistributive information. Simply
put, productive facts are those facts
34
that are used to increase wealth. On the other hand, redistributive facts
are those facts that simply reallocate wealth between the contracting
parties. It is information that creates a bargaining advantage that can be
used to redistribute wealth in favor of the knowledgeable party, the
knower, but does not lead to creation of new wealth, or does not grow
the pie.
Professors Cooter and Ulen recognize that their distinction between
productive and nonproductive facts differs from Dean Kronman's
distinction between deliberately and casually acquired information, but
assert that they are related tests in that both distinctions seek to validate
those facts and the search for information or production of facts that is
efficient and, therefore, encourages and rewards that efficient behavior.3 5
Professors Cooter and Ulen also concede that the distinction between
productive and redistributive facts is not often clear and that most new
facts acquired by the knower are mixed in that they both produce new
wealth and redistribute existing wealth. Hence, the authors conclude
that most new facts acquired by the knower are mixed, and that in their
analysis of contracts that are enforced versus those that are set aside for
32. See infra notes 36-42 and accompanying text. Access to information is a very
broad term because the seller will always know more than the buyer even if the buyer
has exercised the right to inspect the property and has done so thoroughly.
33. COOTER& ULEN, supra note 5, at 281-86.
34. Id. at 281.
35. Id. at 283 n.37.
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nondisclosure of information, the contracts that are enforced are those
where the knower has knowledge of mixed facts-productive and
redistributive-and those that are set aside are those where the knower
has knowledge of purely redistributive facts and fails to disclose them to
the knowee. From these scenarios, they draw the conclusion that
knowledge and the creation of private rights in productive facts should
be encouraged, and gains based on private knowledge of purely
redistributive facts should be discouraged through the use of contractual
remedies.
Without going into too much detail, it should be obvious that Dean
Kronman's theory of deliberate versus casually acquired facts and
Professors Cooter and Ulen's theory of productive versus redistributive
facts can be combined to produce one theory in which there are four
cells. The cell that would be the most supportive of nondisclosure on the
part of the knower would be that cell that consists of deliberately
acquired information that is productive.
Its antimony is casually
acquired redistributive facts in which disclosure is required under both
theories. In these two bipolar extremes, one would expect to see the
cases decided consistently-no disclosure required for deliberately
acquired productive facts and disclosure required for casually acquired
redistributive facts known to the knower. If these theories are accurate
or at all explanatory, one would expect to see mixed outcomes in cases
in which the two theories point in different directions-deliberately
acquired facts that are redistributive or casually acquired facts that are
wealth-enhancing or wealth-producing.3 6
36. Professor Scheppele's theory, which is premised on access and is discussed
supra at note 31 and accompanying text, can also be combined here to strengthen the two
bipolar cells that lead to divergent outcomes in all cases. By that I mean, if the
deliberately acquired and productive fact is accessible to both parties and discovered by
one, this fact should not have to be disclosed by the knower. Conversely, if the casually
acquired, distributive fact is accessible to only one party-or accessible to the knowee at
a much greater cost-then the fact should be disclosed.
At this time I want to disaggregate Professor Scheppele's theory from the theories of
Dean Kronman and Professors Cooter and Ulen because I believe her theory may, in
many cases, be too subjective and difficult to apply for the trier of fact. Determining
access to facts or knowledge and the costs of that access or knowledge will require some
inquiry into the state of knowledge or mind of both parties before the fact is discovered.
That inquiry differs from the hindsight, or later, determination regarding whether a fact
is deliberately acquired, which focuses on the objective steps the knower took to gain
control or knowledge of the pertinent fact, or whether a fact is productive or merely
redistributive, which simply requires a calculation of wealth affects after the fact is
known by one or both parties. However, Professor Scheppele's theory is pertinent to the
residential real estate market given its focus on access that is clearly divergent and
dispositive in residential real estate transactions where the seller, or knower, has lived in
the property being sold and the buyer, or knowee, does not and will not have access until
after the transaction is concluded.
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Mapping these theories onto the sale of residential real estate, one
initially faces a hurdle: How did the doctrine of caveat emptor-"let the
buyer beware"-with its concomitant lack of duty of disclosure, emerge
in the sale of residential real property? A quick review of the three
theories discussed and their applicability to the residential real estate
transaction almost immediately leads to the contrary conclusion that the
seller of residential real estate-the knower in the hypotheticals aboveshould have a duty to disclose information known to the buyer-the
knowee above-given any of the three theories posited to explain and
require the disclosure of information. That, of course, is the antithesis of
the caveat emptor rule, which, in its purest form, requires that the seller
say nothing to the buyer with respect to the condition of the premises
sold.3 7
Take, for example, the homeowner who has owned her home for a
period of ten years and who during that time has incurred costs for
plumbing, electric, and heating repairs, as well as paid a professional
exterminator to rid the house of termites, the latter of which were
discovered in the second year of occupancy. As a result of this owner's
occupancy of the premises, she is aware that when it rains more than
four inches in a twenty-four hour period, the basement floods. Similarly,
the owner-seller is aware that the termite infestation will more than
likely reoccur unless the home is treated annually. Finally, although this
will become important later, the homeowner is selling the house because
her spouse was murdered in the house by an intruder, and she no longer
views the house as a home.38
37. Indeed, in certain situations silence is a safe harbor that the seller should be
encouraged to take advantage of lest the seller be accused of misrepresenting facts by
omission:
The doctrine of caveat emptor does not protect the seller of a pre-owned home
from tort liability for affirmative misrepresentation or concealment of defects
in the property. Though some "puffing" and sales talk is permissible, sellers
must act reasonably in order to avoid a future misrepresentation claim. Sellers
must disclose any known information that might affect the buyer's decision to
purchase, and they are held just as liable for concealing the truth as they are for
telling outright lies.
JOHNSON, supra note 9, § 2.06(B)(2) (footnote omitted).
38. I posit this last fact situation to plumb the issues that have arisen recently
regarding whether there is a duty on the part of the seller to disclose so-called
reputational or psychic harms associated with the dwelling to the putative buyer. For
further discussion, see infra note 47 and text accompanying notes 109-10.
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At common law, as long as these conditions were not dangerous and
latent, and there was no active concealment of any of these conditions or
misrepresentations about them if asked directly, the seller had no duty to
disclose these conditions even though the conditions were material and
relevant to the price of the property sold. If the buyer did not discover
these conditions during his inspection, and if there were no warranties or
guarantees with respect to the sale-the property is sold as is-the buyer
purchased the property with its defects and the buyer was forced to
accept said property in that condition with no recourse-rescission or
damages-against the nondisclosing seller.
And yet according to the three economic theories regarding disclosure
of information, the selling homeowner presents perhaps the clearest case
that the homeowner should disclose all of the information described
above to the buyer before the sale is consummated to accomplish the
efficient and correct outcome. Taking first the most prominent theory,
that put forth by Dean Kronman,39 it would appear obvious that
information acquired by the homeowner in the context of owning one's
home is or will be defined as information that is casually acquired as
opposed to information that is the product of an investment and
deliberately acquired. n
Without going into great, and I believe unnecessary, detail, I think it is
beyond doubt that a homeowner's acquisition of the information described
above regarding the quality of the house in question is information that
is casually acquired, like that information acquired by the businessperson
riding the bus overhearing a conversation between two other riders that
provides the businessperson with valuable information regarding an
initial public offering (IPO). 41 The principal purpose for purchasing the
house is to reside in the house-to occupy the dwelling. The information
regarding the quality of the house is information that is ancillary to the
occupation of the house. In other words, the costs of producing that
information would have been incurred as a byproduct of living in the
home, and the costs to produce that information would have been
incurred whether the information in question would have actually been
39. See supra notes 19-28 and accompanying text.
40. In some cases, the individuals who supply information have obtained it by
a deliberate search; in other cases, their information has been acquired
casually. A securities analyst, for example, acquires information about a
particular corporation in a deliberate fashion-by carefully studying evidence
of its economic performance. By contrast, a businessman who acquires a
valuable piece of information when he accidentally overhears a conversation
on a bus acquires the information casually.
Kronman, supra note 1, at 13 (footnotes omitted). For a definition of deliberately acquired
information, see supra note 23 and accompanying text.
41. See Kronman, supra note 1, at 13.
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produced.42 The production of this information was a byproduct of the
costs of living in the home and not the result of any deliberate search for
any information or expenditure of special costs to obtain information
that would not otherwise be produced. I can belabor the point, but it
appears to be an obvious one. The typical information possessed by a
homeowner acquired as a byproduct of the occupation and use of a
dwelling would appear to be the prototypical example of casually
acquired information. Therefore, that information is clearly the type of
information that, per Dean Kronman's theory, must be disclosed, if
relevant to the other contracting party-the vendee-knowee purchasing
the property.
Turning to the two other theories discussed above, it should also be
obvious that the homeowner possesses information that is clearly
redistributive as opposed to information that will produce new wealth.
The fact that the basement floods periodically, that the home has been
infested by termites, and that a murder took place in the home will not in
any circumstances create any new wealth for either the seller or the
buyer in this situation. Quite the contrary, the possession of this information
by one party, to the exclusion of the other party, could and should lead to
the redistribution of the wealth between the parties as reflected in the
sales price. The buyer may pay more than warranted for the house
without knowledge of the relevant information. Conversely, if the buyer
is aware of the property's defects, the price paid for the property may be
reduced, leaving more wealth in the hands of the buyer and providing
less to the seller.
Examining the last theory discussed above, access to information put
forward by Professor Scheppele, this is yet another example where the
answer is obvious: the seller who has occupied the house for several
years has much better access to the information than the buyer, even one
who has hired an inspector to undertake an inspection of the building,
and therefore should be required to disclose that relevant information to
the buyer. Again the point is an obvious one, but living in the home full
time over a period of years clearly provides the seller with more and
better access to the dwelling and the pertinent facts regarding the quality
42. Id. In this setting, information that would be deliberately acquired would be
information obtained by a housing inspector if hired by the purchasing vendee to inspect
the home and provide the vendee with a report on the quality of the house. That
information "entails costs which would not have been incurred but for the likelihood,
however great, that the information in question would actually be produced." Id.
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of the dwelling as opposed to the episodic and limited searches or
inspections undertaken by the putative buyer and the buyer's agents.
Consequently a review of all the theories reveals a puzzle-all point to
disclosure by the vendor, the knower, to the vendee, the knowee. Yet
the rule is the opposite: at common law the seller has no duty to disclose
any facts regarding the quality of the premises to the vendee under the
common law doctrine of caveat emptor. Thus, none of these theories
can adequately explain the rationale and development of the doctrine of
caveat emptor with respect to the sale of realty and its evolution in the
common law.
However, after giving the matter some thought and doing some
historical homework, I have reached the conclusion that all three theories
detailing when it is efficient to disclose information-deliberately acquired
facts, wealth-producing facts, and facts inaccessible or less accessible to
the other contracting party-do indeed support the use of a historical
development of caveat emptor in the sale of real estate. The conundrum
is resolved via the recognition that the caveat emptor doctrine, in its
pristine form, only requires the disclosure of latent dangerous defective
conditions and has never required the dissemination or disclosure of
patent or obvious defects. Indeed, as the doctrine of caveat emptor has
eroded to become a shell of the pristine common law doctrine, the one
constant rule embodied in the doctrine, no matter what the exceptions or
limitations on the common law doctrine, is that the seller, the knower,
does not and has not ever had the duty to disclose patent or obvious
defects to the knowee. It is that limitation on the erosion of the caveat
emptor doctrine that holds the key to the explication of the primary
premise of this Article-the doctrine of caveat emptor, its erosion, and
its reemergence in the guise of caveat emptor light are consistent with
economic theories requiring the efficient disclosure of information from
one contracting party to the other.
Thus, it is not the doctrine of caveat emptor that has evolved to
accommodate efficient legal theories or to adapt to the alleged change in
bargaining power and knowledge by the contracting parties with respect
to the sale of real estate, which is said to be the usual reason for the
erosion of the common law doctrine of caveat emptor.4 3 Instead, the
43. The sale of residential property, traditionally viewed as an arena involving
buyers and sellers, is increasingly the subject of legislative scrutiny. Previously,
buyers and sellers, dealing at arms length, were presumed to have the essential
skills and bargaining power to negotiate an equitable transaction. Buyers were
presumed to investigate each potential purchase to determine whether the
particular piece of property met the buyer's criteria. Upon discovering any
undesirable characteristics or "defects" in the parcel, the buyer presumably
presented these concerns to the seller and either used the information as a
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focus should be on the evolution of the character of the property
transferred that is the subject of the doctrine that has shaped and caused
its evolution to its current form consistent with the three economic
theories detailing the efficient disclosure of information. That fact is
tacitly recognized by Dean Kronman when he concludes that with one
exception-patent defects-the information possessed by a typical
homeowner is casually acquired information, or information that would
have been acquired in any event. As a result, the selling homeowner
should disclose that information which is contra to the doctrine of caveat
emptor. 4
Although Dean Kronman does not explain why caveat emptor was
initially the doctrine employed by the courts with respect to the sale of
realty, he does address the situation in which a selling party is privileged
not to disclose even casually acquired information with respect to the
sale of realty. The exception occurs with respect to patent or obvious
defects. Since this class of defects is obvious, its disclosure is unnecessary
since the party on whom the disclosure burden is or would be placed
assumes that the other party is already in possession of that information
given the patent nature of the defect.4 The key is tying that observation
to the type of property being sold at the time that the caveat emptor
doctrine was developed.
At the time the common law doctrine of caveat emptor developed, the
property being transferred was agrarian in nature and disclosure of any
information was unnecessary because the party upon whom the
bargaining tool to adjust the consideration in the transaction or decided that the
defective property was no longer desirable and terminated the negotiations.
This format was the means offacilitating real estate transactionsfor many
years, until it was consideredout of harmony with modern concepts ofjustice.
Steven C. Tyszka, Note, Remnants of the Doctrine of Caveat Emptor May Remain
Despite Enactment of Michigan's Seller Disclosure Act, 41 WAYNE L. REV. 1497, 1497
(1995) (emphasis added) (footnotes omitted).
44. Kronman, supra note 1, at 23.
45. Id. With respect to latent defects and the emerging trend to require their
disclosure and the concomitant erosion of the doctrine of caveat emptor, Dean Kronman
defends that erosion and characterizes it as a beneficial development from an efficiency
or economic standpoint because when the information is casually acquired, the
disclosing seller-the knower-is the cheapest cost avoider. If the rule should be the
obverse, it would be inefficient in that the "seller has made a deliberate investment in
acquiring his knowledge which he would not have made had he known he would be
required to disclose to purchasers of the property any defects he discovered." Id. at 25.
The common law doctrine of caveat emptor, its erosion, and its current iteration are all
efficient.
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disclosure burden was placed-the knower-seller-assumed that the
other party-the knowee-buyer-was already in possession of that
information. The buyer was in possession of this information because
the entire quality or character of the premises was accessible to the buyer
upon a reasonable inspection of the premises. As a result, at the time the
doctrine developed, disclosure of defects of the typical agrarian structure
would have been unnecessary since the party upon whom the disclosure
was placed correctly assumed that the other party-the purchasing
party-was in possession of that information as a result of that party's
inspection of the premises. At this stage in the development of real
property, all defects were patent and discoverable by the buyer.
The problem with the application of the caveat emptor doctrine to
modem residential dwellings is that the original premise supporting the
use of the common law doctrine of caveat emptor is no longer true-all
defects are no longer patent. The common law caveat emptor doctrine
presupposes that all defects in a property are patent and that there is no
need for the communication of them from seller to buyer. Today,
however, most defects are latent and not easily discoverable upon a
visible inspection, even a carefully conducted inspection, of the premises. It
is the change in the nature of the dwelling that is the subject of the
doctrine, the possession of valuable casually acquired information by the
seller, and, lastly, the concomitant duty to disclose imposed on sellers
today in most jurisdictions that have caused the erosion of the common
law doctrine.
Hence, over time patent defects became latent defects, requiring
disclosure which is consistent with the economic theories addressed above
because the knower was aware of these latent defects and acquired that
information not as a result of a deliberative search for information.
Furthermore, the seller is clearly the party who has the most efficient
access to the dwelling to determine the quality of the premises demised.
These facts, coupled with the additional fact that the knowledge of these
latent defects do not create wealth, but simply cause the redistribution of
wealth, explain why the common law doctrine of caveat emptor is
riddled with exceptions and is no longer viable in today's society.
In Part II, I turn my attention to the evolution of the doctrine of caveat
emptor to demonstrate how the changing character of the property being
conveyed forced the exceptions to the caveat emptor doctrine that have
now swallowed the rule. In so doing, I confront and address a new issue
raised by the evolution of the caveat emptor doctrine-the demise of
caveat emptor in its common law iteration and its reemergence as caveat
emptor light. As the common law caveat emptor doctrine became
inapposite to the sale of real property, courts, and subsequently legislators,
were left to decide which facts, those that are casually acquired and
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redistributive being the easiest to identify, must be disclosed by the
seller to the buyer.
I hope to demonstrate that because casually acquired information is
determined after the sale has occurred in a transaction in which no new
wealth is being created, because the sale of a house typically does not
cause the creation of new assets or growth in existing assets, it is quite
easy to come to the conclusion that any knowledge possessed by the
seller-knower is casually acquired, redistributive information that
must or should have been disclosed to the buyer-knowee. The court's
hindsight-based decision that facts must be disclosed has ultimately
caused the abolition of the doctrine of caveat emptor by essentially
requiring the disclosure of every fact.
The problem with the disclosure of all casually acquired information
is that it is hard to police and discriminate between casually acquired and
deliberately acquired information when the judgment is made ex post in
a setting like the sale of residential real estate. The problem is
exacerbated because if the seller lives in the home, the act of living in
the home will result in the acquisition of casually acquired information
and deliberately acquired information, and it will be impossible to
distinguish between the two in any principled way.
In Part II, I address a related problem created by the ex post nature of
the determination of whether facts are casually or deliberately acquired
in the context of a residential real estate sale. Once it is recognized that
litigation will occur regarding whether disclosure was required for those
facts which were not disclosed-this seems rather obvious but raises an
important point that facts adequately disclosed create issues perhaps
involving misrepresentation or fraud, but not nondisclosure-what
courts are essentially deciding is whether a fact should have been
disclosed after the relevance of the fact, at least to the buyer who is
ostensibly bringing the lawsuit, has already been at least partially
This hindsight or ex post determination will almost inevitably
proven.
result in a decision that it should have been disclosed if the fact affects
the value of the premises, even those facts that the seller had no reason
to know of or facts that the seller in good faith believed were patent or
insignificant with respect to its impact on value. The erosion and
obliteration of the common law doctrine has, in effect, caused the seller
to become the guarantor of the value of the premises as it exists on the
46.
See infra notes 63, 65, and accompanying text.
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date of sale, warranting its value as to the state of facts as they exist on
the date of sale.47 Hence, the doctrine of nondisclosure has come full circle
to become the doctrine of total and absolute disclosure as to all relevant
facts, with the relevant facts being determined much later, with hindsight,
by a trier of fact.48
This has led to the final piece of the puzzle-why caveat emptor light
has emerged. In a juridical world in which the relevance of facts are
decided only after their relevance has been proven, it may be impossible
for the seller to adequately perform its duty of disclosure if the seller,
acting in good faith, is unaware of the fact, the relevance of the fact to
the buyer or the larger real estate market, or its impact on value.4 9 The
seller, as guarantor of the value of the premises, may be unwilling to act
as guarantor as to those unknown facts or facts that later cause a
diminution in value over which the seller has no control. This has
created an incentive for sellers to limit their duty of disclosure in order
to limit their role as guarantors as to the value of the premises. This has
led to the reemergence of caveat emptor in the guise of caveat emptor
light. Caveat emptor light realigns the relationship of the parties consistent
with their expectations and establishes appropriate default rules that the
parties can bargain in light of given their respective positions. Furthermore,
caveat emptor light is premised on the recognition that neither party is
the so-called jack-of-all-trades agrarian farmer that represented the
typical buyer and seller at the time the doctrine of caveat emptor
emerged and came to dominate.50
II. CAVEAT EMPTOR: A COMMON LAW DOCTRINE GONE AWRYFOR GOOD AND EFFICIENT REASONS
The caveat emptor doctrine is a historical anomaly. Although originally
conceived in the Middle Ages to allocate disclosure rights between
47. See, e.g., Van Camp v. Bradford, 63 Ohio Misc. 2d 245, 259-60 (C.P. 1993)
(holding the seller liable for not disclosing the property's psychological stigma-violent
crimes that had occurred at or near the premises-to the buyer). Van Camp and cases
like it represent the cutting edge of disclosure cases because information is not "visible"
in the sense of a patent defect, but it is or can be discovered in many cases by a thorough
search of the public record which would disclose the fact that a crime was committed on
the subject property, that the owner died of AIDS, or that the house is haunted. For more
on the latter, see Stambovsky v. Ackley, 572 N.Y.S.2d 672, 674 (App. Div. 1991),
discussed infra at note 85 and accompanying text.
48. For further discussion, see infra notes 78-79 and accompanying text.
49. It is more common than you might think that a seller may not be aware of facts
with respect to the quality of the premises that later cause a significant diminution in
value. For a discussion of this issue, see infra notes 107-09 and accompanying text.
50. For further discussion of this point, see infra notes 113-15 and accompanying
text.
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buyers and sellers of real property, the doctrine survived for centuries
even though the nature of the property governed by the doctrine
changed-agrarian versus residential-as did the respective knowledge
of the parties to the transactions-the prototypical jack-of-all-trades
farmer in the Middle Ages to the clueless buyer and seller who have
difficulty changing light bulbs in a residence. However, its survival was
not without cost. The doctrine became riddled with exceptions and
ultimately has been effectively abolished in several jurisdictions.
Perversely, the judicial and statutory abolition of the caveat emptor
doctrine has paved the way for the return of the doctrine, a doctrine I
now call caveat emptor light.
To truly understand the issue, and obviously the evolution of the
doctrine of caveat emptor, a historical exegesis is appropriate to place
the issue in its appropriate historical context. Hence, this Part is divided
into three chronologically oriented subparts. In the first, I briefly detail
the original (or more accurately, historical) formulation of the doctrine
of caveat emptor tracing its origination to England, of course, and the
common law. From there, I document the erosion of the document by
cases and statutes, focusing on the seller and the brokers, who are agents
of the sellers and who have the duty to disclose certain information that
was previously protected by the common law doctrine of caveat emptor.
I conclude with my thesis that what is emerging is something akin to
caveat emptor light, which requires the selling homeowner to disclose
selective information or expressly disclaim the communication of any
information from seller to buyer, reestablishing the default rule of caveat
emptor as it existed at common law. That will lead to a discussion in
Part III of the optimal rule for disclosure and whether caveat emptor
light is such a rule.
A. The Common Law Baseline
Caveat emptor is part of a much larger Latin phrase which roughly
translated means "let the buyer beware, who ought not be ignorant of the
amount and nature of the interest he is about to buy, exercise caution."'"
The doctrine first emerged in ancient Rome and was quickly embraced
as a common law rule governing residential real estate transactions in
51.
See James R. Pomeranz, Note, The State of Caveat Emptor in Alaska as it
Applies to Real Property, 13 ALASKA L. REV. 237, 237 (1996).
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sixteenth-century England.5 2 At the time the rule developed, England
was largely an agrarian society and the asset to which the rule applied,
land being sold, was agrarian as well, with the land being transferred
worth much more than the value of the structures built upon the land.53
Since the structures constructed upon the land were so basic, and the
knowledge of their quality was equally accessible to both parties-the
buyer and seller-the buyer was easily able to inspect the land and
discover any defects in the premises conveyed. Essentially, the buyer
and seller had equal access to the condition of the premises and
possessed equal bargaining power with respect to their knowledge and
value of the premises conveyed.54
Pursuant to the traditional doctrine of caveat emptor, the seller was
under no obligation to disclose facts known to him but unknown to the
buyer, irrespective of their impact on value or use of the premises.55 The
buyer's recourse was to carefully inspect the premises for defects and to
ensure that the premises were suitable for their intended purpose. If the
buyer's inspection revealed some material defect, the buyer could reject
the deal, negotiate further regarding price or remediation of the defect,
or demand an express warranty from the seller covering the defect.56
Indeed, the seller was under no duty to say anything with respect to the
condition of the premises. In this situation, silence was golden.5 7
Essentially, the common law doctrine of caveat emptor does not
require a seller to disclose defects and precludes recovery by a buyer for
structural and other defects in the property being sold where: (1) the
alleged defective condition is open to observation and is discoverable
upon a reasonable inspection; (2) the buyer has the opportunity to
examine the premises; and (3) there was no fraud on the part of the
vendor with respect to the condition of the premises.58
Simply put, under the traditional doctrine of caveat emptor, the seller
is not required to disclose to the buyer any facts that might affect the
52.
See Stormont v. Astoria Ltd., 889 P.2d 1059, 1062 n.5 (Alaska 1995); Nicola
W. Palmieri, Good Faith DisclosuresRequired During PrecontractualNegotiations, 24
SETON HALL L. REv. 70, 110 (1993).
53.
See Caryn M. Chittenden, From Caveat Emptor to Consumer Equity-The
Implied Warranty of Quality Under the Uniform Common Interest Ownership Act, 27
WAKE FOREST L. REV. 571, 578 (1992).
54. Id.; see also Conklin v. Hurley, 428 So. 2d 654, 656-57 (Fla. 1983)
(summarizing the history of caveat emptor).
55. Chittenden, supra note 53, at 578.
56. Id.
57. As Lord Caims stated in the landmark case of Peek v. Gurney, (1873) 6 L.R.E.
& I. App. 377, 403 (H.L.) (U.K.): "Mere non-disclosure of material facts, however
morally censurable ... would in my opinion, form no ground for an action in the nature
of an action for misrepresentation."
58. See Jacobs v. Racevskis, 663 N.E.2d 653, 655 (Ohio Ct. App. 1995).
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value of the premises.5 9 Another way of stating this is that if the seller
said nothing about the condition or value of the property to be conveyed
in her negotiations with the buyer, the seller could not be liable for any
defects in the property sold to the buyer that are subsequently discovered
by the buyer upon taking possession of the conveyed premises. In its
pristine form, the doctrine of caveat emptor protected the silent seller of
real estate whether the defects were latent or patent, whether they were
known to the seller or not, and whether they were discoverable by
the buyer upon a cursory or thorough inspection. Without active
misrepresentation or fraud, of which more anon, 60 the buyer purchased
the property as is and was indisputably and irrevocably the owner of the
property following the transfer of title.
As previously indicated, the common law doctrine of caveat emptor
does not bar recovery against the seller when the real estate seller has
engaged in misrepresentation with respect to the condition of the
demised premises. Notwithstanding the caveat emptor doctrine, under the
common law, there are three theories pursuant to which the buyer can bring
an action against the seller based on some species of misrepresentation
by the seller: (1) intentional misrepresentation or fraud; (2) negligent
misrepresentation; and (3) so-called innocent misrepresentation. Under any
of these three theories, the buyer must prove that the innocently,
negligently, or intentionally misrepresented fact was material and 6that
the buyer justifiably relied on the representation in making the purchase. '
Quite clearly the common law doctrine of caveat emptor does not
protect the seller against the buyer's claim when the seller has actively
misrepresented the condition of the premises and in which the
purchasing plaintiff can prove that the seller made:
"(1) a material representation which is (2) false and (3) known to be false, or
made recklessly as an assertion of fact without knowledge of its truth or falsity,
and (4) made with the intention that it be acted upon, and (5) acted upon with
damage .. " In addition to these elements, it must also be proved that the
[purchasing] plaintiff "(6) relied upon the representations, (7) was induced to
59. Again, the seller cannot misrepresent, by concealment or actve statements, the
condition of the premises to the detriment of the buyer. For a discussion of the doctrine
of misrepresentation, see infra notes 61-67 and accompanying text.
60. See infra note 62 and accompanying text.
61.
Kenneth M. Nakasone, Seller Beware: New Law Protects Hawai 'i Home Buyers,
18 U. HAW. L. REV. 981, 984 (1996).
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act upon them, and (8) did not know them to be false, 62and by the exercise of
reasonable care could not have ascertained their falsity."
Each of the numbered elements must be proven in order to establish a
cause of action for fraud or intentional misrepresentation.
As indicated above, the caveat emptor doctrine is or at least began as a
rule of silence. If the seller remains silent and takes no steps to warrant
the condition or quality of the premises, caveat emptor provides a safe
harbor for the seller. However, once the seller begins to speak to the
quality of the premises, even short of fraud, courts are willing to impose
a duty on the seller to be truthful and nonnegligent with respect to those
representations. Indeed, the erosion of the common law caveat emptor
doctrine began and continues with respect to these nonfraudulent cases
of misrepresentation. It is to these cases, and the erosion of the doctrine,
that I now turn, focusing specifically on court-imposed duties to disclose.
B. The Erosion of the Doctrine-theBeginning of Efficient
Mandatory DisclosureRules
The beginning of the erosion of the common law caveat emptor
doctrine began with the negligent and innocent misrepresentation cases.
These cases, which are unremarkable, laid the groundwork for the
usurpation of the common law doctrine of caveat emptor in cases where
the seller did exactly what was typically required by the caveat emptor
doctrine-remaining silent and making no representation. Furthermore,
the cases of negligent and innocent misrepresentation began to exhibit
the efficiency norms produced by the economic theories to disclose
information that are addressed above. In other words, a close review of
these cases reveals that what is actionable is not the communication,
which in some sense is innocent and lacks the scienter necessary to
prove fraud, but the effect the communication has on the duty to gather
information on the party, the buyer, to whom the communication is
made. It is the effect of the communication on the buyer that negates the
safe harbor, and the rationale for, the caveat emptor doctrine.
Negligent misrepresentation occurs when one party to a transaction
fails to exercise reasonable care or 'competence in obtaining or
communicating material information about the transaction or the property
being sold pursuant to the transaction. As a result of this negligence or
inadvertence, the seller supplies false information to the buyer upon
62. Jeff Sovem, Toward a Theory of Warranties in Sales of New Homes: Housing
the Implied Warranty of Advocates, Law and Economics Mavens, and Consumer
Psychologists Under One Roof, 1993 Wis. L. REv. 13, 18 n. 17 (quoting Coffin v. Dodge,
76 A.2d 541, 543 (Me. 1950)).
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which the buyer relies in going forward or completing the transaction.
Thus, when a seller, without actual fraudulent intent (scienter), fails to
exercise reasonable care and provides the buyer with incorrect information
regarding the condition of the soon-to-be demised premises in a residential
real estate transaction, the seller is liable for negligent misrepresentation.
A few cases will illustrate the parameters of the cause of action. In
Asleson v. West Branch Land Co., the seller was liable to the buyer when
the seller failed to verify the exact acreage that was being sold and
asserted that the property was zoned for thirty-five townhouses, a fact
that appeared in the multiple listing
service.63 Instead, the property was
64
zoned for only thirty such units.
Quite often the case for negligent misrepresentation is made against
the seller's agent, the broker, for representations made by the broker on
behalf of its principal, the seller, to the buyer. Often the broker is
passing on information it received from the seller, and it is the broker's
negligence in verifying the information before communicating it to the
buyer that results in the successful cause of action against the seller.65
Innocent misrepresentation represents even more of an incursion on
the doctrine of caveat emptor and imposes liability when there is no
fault-no intent to deceive and no negligence with respect to the
representation on the part of the seller. As such, innocent misrepresentation
is most aptly described as a species of strict liability. 66 To be clear,
innocent misrepresentation occurs when the seller makes a misrepresentation
63. 311 N.W.2d533,535 (N.D. 1981).
64. Id. It is also possible for the seller to orally misrepresent a relevant fact about
the property to the purchaser. Thus, if the seller orally informs the buyer that she owns
land beyond a fence boundary that is suitable for gardening and, unknown to the seller,
the boundaries are different from those described in the deed and the seller's
representations, a cause of action for negligent misrepresentation will be sustained. See
Frona M. Powell, Relieffor Innocent Misrepresentation:A Retreat From the Traditional
Doctrine of Caveat Emptor, 19 REAL EST. L.J. 130, 132 (1990).
65. A case in point is Tennant v. Lawton, 615 P.2d 1305, 1308 (Wash. Ct. App.
1980), in which the seller told the broker-realtor that the property in question had passed
a percolation test, thereby making the property saleable, and the realtor conveyed the
property to the buyers without verifying same. After the closing, the buyers discovered
that the property had not passed a percolation test and were subsequently unable to
obtain a septic tank permit. Id. The Washington Court of Appeals held that the realtor
had negligently misrepresented a material fact to the purchasers by "fail[ing] to take the
simple steps within her area of expertise and responsibility which would have disclosed
the absence of any health district approved site on the subject property." Id. at 1310.
66. Clarance E. Hagglund & Britton D. Weimer, Caveat Realtor: The Broker's
Liability for Negligent and Innocent Misrepresentations,20 REAL EST. L.J. 149, 153
(1991).
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of a material fact upon which the buyer justifiably relies in deciding to
act or refrain from acting, even though the misrepresentationis not made
fraudulently or negligently. In this setting, once the representation is
made, the seller and the seller's agents have constructive knowledge of
the defects of the real estate as it pertains to the misrepresented fact,
whether or not those defects are discoverable by a reasonable
inspection.67
What is interesting and revealing about these cases is that the seller
has no duty to make representations-to convey information-to the
buyer, but in so doing becomes the warrantor of the information
conveyed. In this situation, the seller can avoid liability for innocent and
negligent misrepresentation simply by remaining silent-avoiding any
representations concerning the absence of defects or other information
that is communicated to the buyer.68 Hence, the safe harbor for the seller
in this setting is the common law doctrine of caveat emptor, pursuant to
which the seller remains silent, and the buyer purchases the property
based solely on the buyer's knowledge of the property gleaned from the
buyer's inspection of the demised premises.
Furthermore, it is the recognition that the seller has deviated from the
safe harbor of nondisclosure provided by the common law rule of caveat
emptor that provides the key to explaining these cases as exceptions to
the common law doctrine. Such recognition further validates the economic
theories detailed above regarding optimal disclosure rules. Recall that
under the common law doctrine of caveat emptor, it is assumed that the
parties have both equal bargaining power and equal access to information
concerning the condition of the premises to be conveyed. Consequently,
if the seller makes no representations, it is incumbent upon the buyer to
make her own inspection of the premises to determine its quality.
That calculus changes radically when the seller makes either a
negligent or innocent misrepresentation to the buyer, and there is the
requisite reliance. In this case the reliance means that the buyer, relying
on the information conveyed by the seller, opts not to inspect the
premises in such a manner to verify the misinformation conveyed to the
buyer by the seller, instead relying on the mistaken state of affairs to the
buyer's detriment. By making the communication to the buyer, the
seller is warranting that she has access to information that the buyer
cannot obtain or need not obtain given the seller's representations. That
67. Id. at 152.
68. Of course, in the case of negligent misrepresentation, the seller can also avoid
culpability by conveying accurate, nonnegligent information about the condition of the
premises to the buyer. Silence, however, will ensure that nonnegligent information is not
conveyed since no information of any type would be conveyed from seller to buyer.
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eliminates the buyer's duty to further investigate to obtain the requisite
information and imposes liability on the seller for the damages or harm
that ensues.
In addition, this deviation from the common law rule of caveat emptor
makes perfectly good sense when it is remembered that the seller is
privileged to make no representations regarding the state or condition of
the premises. By making the representation, either innocently or
mistakenly, the seller is indicating that this is information that the seller
69
acquired in her ownership of the property that is both casually acquired
and redistributive, as opposed to wealth-enhancing. 70 This is self-evident
from the nature of the communication. If the information is the product
of deliberate investment or wealth-enhancing, as described above, 7' it
would be inefficient and not in the seller's interest to convey same to the
buyer.72
Take for example the cases that are addressed above with respect to
innocent and negligent misrepresentations. At first glance it might
appear that the acreage being conveyed and how many units can be built
upon the property as a result,7 3 the boundaries of a property as stated in a
deed,74 and lastly, whether a property has passed a percolation test that
will allow for a certificate of occupancy because a septic system may be
installed,75 are facts that are or may be the product of deliberate
investment-although I think that is stretching it; perhaps the percolation
case provides the best case for this argument. However, that determination
is irrelevant because in all three settings or cases the information is in
the public domain and subject to verification, thus making it the
equivalent of casually acquired information-information that the seller
has no privilege or property right in protecting from others. The three
facts that were the subject of the misrepresentation were easily subject to
verification. However, it is the very fact of the representation that
precludes the investigation that could lead to the acquisition of
information. As a result, information that is available to both parties is
controlled by one party. Moreover, by usurping the buyer's right to
69.
70.
71.
72.
73.
74.
75.
See
See
See
See
See
See
See
supra notes 25-27
supra notes 33-35
supra notes 25-35
supra notes 19-22
supra note 63.
supra note 64.
supra note 65.
and
and
and
and
accompanying
accompanying
accompanying
accompanying
text.
text.
text.
text.
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obtain that information, the seller is warranting the quality and veracity
of the information and is therefore held liable for both negligent and
innocent misrepresentations.
Similarly, the information conveyed by the seller to the buyer is not
wealth-enhancing information, but simply redistributive. This also flows
from the fact that the information is publicly available, and the market
has already internalized the production and publication of the information
in the price of the property.
Consistent with Professor Scheppele's theory regarding the efficient
disclosure of information, the information conveyed to the buyer by the
seller in the negligent and innocent misrepresentation cases is, somewhat
perversely, information that originally is accessible to both parties,
thereby creating no duty to disclose.76 The subsequent disclosure of the
information from the seller to the buyer in the absence of a duty to
disclose transforms that information into information that has to be
conveyed accurately to the buyer because the mere disclosure of the
information, whether accurate or inaccurate, precludes the buyer from
undergoing further investigation to obtain this information. By conveying
this information, the seller transforms the safe harbor of caveat emptor,
with the expectation that both parties have equal access to information
akin to patent defects, into information that is casually acquired and not
wealth-enhancing, which the seller has the duty to disclose accurately to
the buyer.
The cost of the seller's incorrect dissemination of information is the
negation of the buyer's duty to perform its obligations-undertaking an
inspection of the premises-under the doctrine of caveat emptor. This
forestalls production by the buyer of "information whose acquisition
entails costs which would ... have been incurred but for the likelihood,
however great, that the information in question would actually be
produced. 77 From the buyer's perspective, the seller's representation
precludes the acquisition of deliberately acquired information that is
imposed on the buyer under the common law doctrine of caveat emptor.
Moreover, the buyer is able to rely on the fact that the information being
conveyed to the buyer by the seller is accurate and verifiable because the
seller acquired this non-wealth-enhancing information casually.
76. This information also need not be disclosed pursuant to Dean Kronman's
theory, as well as Professor Cooter and Ulen's theory, due to the fact that although the
information is casually acquired and redistributive, as opposed to wealth-enhancing, it is
nevertheless information that, because of its accessibility, is deemed to be patent, and
imposing a duty on the seller to convey that information to the buyer would be needless
and inefficient.
77. Kronman, supra note 1, at 13.
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The development of negligent and innocent misrepresentations
represents the first erosion of the common law doctrine, and it is a
significant one. However, it is consistent with the economic theories
discussed above detailing when disclosure is imposed on the knowee.
The more significant and, at first glance, puzzling erosion of the caveat
emptor doctrine continued with respect to cases in which there was no
representation, either mistaken or negligent, made by the seller to the
buyer, yet the seller was liable for damages caused by the transfer of the
defective premises. These "no representation" cases seem to fly in the
face of the common law rule of caveat emptor because the seller is doing
exactly what is required by the doctrine: remaining silent.
In these, what I will characterize for want of a better term, "passive
misrepresentation" cases, the courts have laid the groundwork for
imposing a mandatory duty to disclose information. As a result of these
cases, which are now legion, in which the seller says nothing and yet is
held liable for nondisclosure-sometimes designated with the term
"fraudulent nondisclosure"-the caveat emptor doctrine has been
negated.78 As Professor Weinberger has noted:
[C]ourts have recognized a duty to disclose information to prospective
purchasers in a variety of contexts involving cracked foundations, leaking roofs,
structural defects, unstable soil conditions, infestation by cockroaches, and
defective sewage disposal. Additionally, nondisclosure of environmental
contamination, radon, and asbestos has become a fertile source of litigation in
recent years.
A legal duty to "speak up" does not arise simply because two parties may
have been sitting across the bargaining table when a deal was struck between
them. The common theme running through the nondisclosure jurisprudence is
the prevention of situations in which buyers labor under serious misapprehension
and are unable to rationally assess the true level of risk involved in the bargain.
The duty to disclose arises when contracting parties do not stand on equal
footing because
one possesses superior knowledge not reasonably available to
79
the other.
One particularly egregious case is State v. Brooks, in which a buyer
purchased a home with a carbon monoxide leak in the home's snow
78.
See Renee D. Braeunig, Note, Johnson v. Davis: New Liability for Fraudulent
Nondisclosure in Real Property Transactions, 11 NOVA L. REV. 145, 145 (1986); Steven
W. Koslovsky, To Disclose or Not to Disclose: An Overview of Fraudulent
Nondisclosure, 50 J. Mo. B. 161, 161 (1994).
79. Alan M. Weinberger, Let the Buyer Be Well Informed?-Doubtingthe Demise
of Caveat Emptor, 55 MD. L. REV. 387, 402-03 (1986) (footnotes omitted). As discussed
previously, this duty to disclose is also supported by the fact that the information
disclosed is casually acquired information and redistributive in nature.
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melting unit, which the buyer was unaware of and which was not
discoverable by a casual inspection of the premises. 8° The seller,
however, was aware of the defect because his girlfriend and daughter
became ill from breathing the fumes before he sold the house. The
repairman, who serviced the unit and discovered the defect, told the
seller he was playing Russian roulette with his life if he did not get the
system repaired. Instead of making the repairs, the seller hired a realtor
and sold the home to the buyers without disclosing the defect. When the
buyer, his wife, and his four-year-old daughter died of carbon monoxide
poisoning, the seller was convicted of involuntary manslaughter and
Vermont abandoned the doctrine of caveat emptor with respect to
dangerous
conditions that are not discoverable upon an inspection by the
8
buyer. '
In addition to physical defects that impact the quality and the value of
the real estate being conveyed, recent cases have focused on so-called
psychological defects that impair the value of the premises. Like
physical defects, these psychological defects, which are known to the
seller and not to the buyer, give rise to a claim for damages or rescission
with respect to the sale of residential real estate. Again, quoting Professor
Weinberger:
Well-publicized cases involving murder, AIDS, and poltergeists have focused
public and state legislative attention on an evolving legal duty to disclose the
existence of nonphysical, psychological defects to prospective purchasers. The
market value of affected real estate is significantly reduced once potential
purchasers become aware of this information.
As a result, these properties are
' 82
sometimes described as "stigmatized.
Without going through a litany of cases requiring disclosure, it is fair
to note what all of these cases have in common:
[I]n the vast majority of cases, material information about the condition of a
residence will be peculiarly within seller's knowledge and difficult for
purchasers to obtain. Most homebuyers [prospective purchasers] will be unable
to achieve a parity of information with long-time homeowners, even by
conducting a professional building inspection. Judicial recognition that vendors
and purchasers are not equal players
challenges the basic underlying assumption
83
of the doctrine of caveat emptor.
What these cases seem to imply is that when the defective condition is
open to observation or otherwise reasonably discoverable, and a buyer
has an opportunity to inspect the premises before purchasing, the seller
may still perhaps be protected by the doctrine of caveat emptor. The
80.
81.
82.
83.
658 A.2d 22, 24-26 (Vt. 1995).
Id.
Weinberger, supra note 79, at 407 (footnotes omitted).
Id. at 404 (footnotes omitted).
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problem from the seller's perspective is the ex ante determination regarding
what is "open to observation and otherwise discoverable." If the seller
fails to make the requisite disclosure because of the belief that the defect
is open to observation and otherwise discoverable, and the buyer later
claims that the defect was not open, the seller runs the serious risk of
losing if a court later makes a fact-based determination that the defect
was not open to observation or otherwise discoverable. This provides
impetus to the seller to make the requisite disclosures so that the buyer
cannot later claim that the defect was neither disclosed nor open and
discoverable.
The problem, of course, with the sale of a residence is that as to those
matters that are disclosed or open and discoverable (patent defects), no
lawsuits will arise because the parties have contemplated or discussed
those defects, internalizing them in the bargaining process and properly
documenting or acknowledging them. It is only those undisclosed and
undiscoverable defects that will later give rise to a cause of action and
claims by the buyer that the matter should have been disclosed and
counterclaims by the seller that the alleged defect was either obvious,
implicitly disclosed, not material, or not known to the seller in order to
impose a duty to disclose. This uncertainty as to undisclosed matters has
been responsible, in large part, for the erosion of the common law
doctrine of caveat emptor and the imposition of caveat emptor light.
However, before turning directly to the rise of caveat emptor light, it
is important to note that the erosion of the common law doctrine of
caveat emptor becomes explicable if it is acknowledged that the caveat
emptor rule is premised not only on the basis that the information
acquired by the seller is casually acquired and not wealth-enhancing, but
that the seller's duty to disclose is negated because that information is
equally accessible to the buyer upon inspection. When that premise is
eroded, as it is in the cases discussed above, the premise for the entire
doctrine is eroded and a corresponding duty is placed on the seller to
disclose accurate information. It is the quality and the quantity of the
information that has caused the rise of caveat emptor light.
C. Caveat Emptor Light-ProvidingSafe Harborsfor Sellers
Recall that under the common law doctrine of caveat emptor the seller
was privileged to say nothing about the quality of the property and could
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be confident that she would be immune from any subsequent lawsuit84
alleging defective condition of the premises sold. Silence was the key.
In recent years the duty to disclose defects has been imposed on the
seller when the seller knows of facts materially affecting the value or
desirability of the property when those facts are known or accessible to
the seller and not known or accessible by the buyer.8 5 The upshot of all
of these cases is that in many, indeed, most states today, the seller must
disclose not only physical defects that are latent, but also psychological
impairments-so-called stigmatized property-arising out of past events
occurring on the subject premises, including the fact that the house was
formerly a "house of ill repute." This has led to debates regarding which
facts must be disclosed to the seller including, most recently, a debate
regarding whether the seller has to disclose that the house was occupied
by someone who is or was HIV positive given the impact such
occupancy may have on the market value of the premises.8 6
84. Home sellers in the 1950s had no obligation to mention property defects
to buyers as long as they resisted the temptation to conceal latent defects or to
lie about the condition of the property. To become liable for concealment,
sellers would have needed to do more than just keep quiet: they would have
needed to do something such as placing a mattress over a gaping hole to hide
dry rot and termites or painting over water stains from an unrepaired roof leak.
As one commentator put it, in those days, sellers' lawyers could reasonably
have copied a page from Miranda and counseled their clients: "You have the
right to remain silent. Anything you say can and will be used against you
during the contract negotiations."
George Lefcoe, Property Condition Disclosure Forms: How the Real Estate Industry
Eased the Transitionfrom Caveat Emptor to "Seller Tell All," 39 REAL PROP. PROB. &
TR. J. 193, 195 (2004) (footnotes omitted).
85. In Alexander v. McKnight, the court imposed a duty on the seller to disclose
the existence of noisy neighbors to the potential purchasers. 9 Cal. Rptr. 2d 453, 456
(Ct. App. 1992). Similarly, in Reed v. King, the court required the seller to disclose the
fact that multiple homicides had taken place at the residence. 193 Cal. Rptr. 130, 133
(Ct. App. 1983). As previously mentioned at supra note 47, in Stambovsky v. Ackley, the
court, in a very tongue-in-cheek fashion that is worth a read, held that the seller had to
disclose the existence of a poltergeist or ghost residing in the house. 572 N.Y.S.2d 672,
677 (App. Div. 1991). Lastly, in Van Camp v. Bradford, the court required the seller to
disclose that a rape had taken place in the dwelling. 63 Ohio Misc. 2d 245, 259-60 (C.P.
1993).
86. Weinberger, supra note 79, at 409. In an apparent attempt to prevent the
courts from recognizing a wide range of psychological defects creating stigmatized
property, legislatures in seven states-Connecticut, Georgia, Oklahoma, Oregon, Rhode
Island, South Carolina, and Utah-have enacted legislation shielding sellers from
liability for failure to disclose that the subject property was the site of a murder, suicide,
or other felony, or that a member of the seller's household suffers from the HIV/AIDS
virus. In addition, legislatures in four states-California, Florida, Kentucky, and
Texas-have passed laws shielding the seller from liability for failure to disclose that a
member of the seller's household suffers from HIV/AIDS. See Sharlene A. McEvoy,
Caveat Emptor Redux: "PsychologicallyImpacted" Property Statutes, 18 W. ST. U. L.
REv. 579, 579 n.2 (1991).
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Given the cases discussed above, uncertainty has arisen regarding
which facts have to be disclosed from seller to buyer, with the seller
running the risk that at some later date some trier of fact will determine
that there was some fact known to the seller, but unknown to the buyer,
that materially affected the value and should have been disclosed by the
seller to the buyer. This uncertain state of affairs has created two different
results that I collectively term caveat emptor light. The first reaction is
for the legislature, as a result of lobbying by realtors, to create a
mandatory disclosure form that imposes a duty on the seller to disclose
certain facts regarding the condition of the property to the buyer, thereby
abrogating the common law doctrine of caveat emptor. This duty is not
necessarily limited to disclosing defects, and indeed may even extend to
warranting the condition of the premises per the claims made in the
disclosure form. The second development, which seems counterfactual,
is the judicially or legislatively created option on the part of the seller to
make no claims or statements with respect to the quality of the premises
and to sell the premises as is. This latter development looks remarkably
similar to the common law doctrine of caveat emptor, but actually is not.
Taking the former development first, thirty-four states, by my count,
have now detailed statutes requiring general disclosure of the quality of
the premises to be conveyed by either the seller or the seller's realtor
with respect to the condition of the premises.8 7 Many remaining states
require either (1) limited disclosure by real estate brokers retained by the
seller of material or adverse conditions affecting the value of the
premises; or (2) disclosures by sellers of the presence of specific items
designated by the statute such as methamphetamine labs, radon, or
mold.88 As a result, it is fair to conclude that the vast majority of sellers
87.
By my count, thirty-four states have enacted detailed statutes requiring some
sort of disclosure by real estate sellers or brokers or both. See, e.g., CAL. CIv. CODE
§§ 2079-2079.10 (Deering 2008) (requiring disclosure of material facts by the seller's
broker); id. §§ 1102-1102.15 (requiring disclosure by seller).
For example:
88.
(b) A broker engaged by a seller shall timely disclose the following to all
parties with whom the broker is working:
(1) All adverse material facts pertaining to the physical condition of the
property and improvements located on such property including but not
limited to material defects in the property, environmental contamination,
and facts required by statute or regulation to be disclosed which are
actually known by the broker which could not be discovered by a
reasonably diligent inspection of the property by the buyer; and
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of residential property in the United States, pursuant to these statutes,
must disclose information regarding the condition or quality of the
premises that they did not
have to disclose under the common law
89
doctrine of caveat emptor.
These statutes provide a form of safe harbor to the seller regarding the
seller's duty to disclose certain defects. By complying, the seller can be
reasonably assured that she will not be liable for the failure to disclose
material facts that she has a duty to convey to the buyer.
The property condition disclosure form may be embedded in a disclosure
statute, drafted by the state agency responsible for broker licensing, or written
by state and local Realtors associations or brokerage firms. Often, lawyers
prefer using statutory forms, relying upon them as safe harbors, an assured way
of achieving full compliance with the law. But in this situation, no safe harbors
can be found because the disclosure statutes do not purport to pre-empt the
evolving common law. Sellers remain obligated to disclose all known material
latent defects-whether mentioned in the form or not. 90
At the other end of the statutory perspective are those statutes that
allow the seller to sell the property with limited or no representations
with respect to its apparent quality. 91 In certain states, sellers are able to
opt out of any disclosure requirements mandated by statute and
essentially sell the property as is as long as no misrepresentations are
made and latent defects are disclosed. 92 Although there is some
disagreement regarding whether these "waivers" should be allowed, the
seller can obtain something akin to the protection of the common law
doctrine of caveat emptor by availing herself of the statutory safe harbor
(2)
All material facts pertaining to existing adverse physical conditions in the
immediate neighborhood within one mile of the property which are
actually known to the broker and which could not be discovered by the
buyer upon a diligent inspection ....
GA. CODE ANN. § 10-6A-5(b) (2007).
89. Seller disclosure forms usually are four to eight pages, single spaced. The
forms vary considerably in the items covered....
Most of the forms also list structural components, such as driveways,
retaining walls, bearing walls, chimneys, windows, doors, exterior stucco,
floors, foundations, roofs, sewer hook-ups, water systems, sump pumps, cut
and fill, termite and rodent infestation. The better ones ask about the type of
roof (e.g., asphalt, shingle, metal), its age, the date of the last repair or
replacement, and whether the seller has had any specific problems with it, such
as water leakage, ice damming, or other damage, and whether the seller has
made any insurance claims based on such damage.
Lefcoe, supra note 84, at 232-33.
90. Id. at 226.
91. Once again, however, latent defects must be disclosed.
92. "Some disclosure statutes allow sellers to opt out unilaterally, some require the
buyers' consent, and some prohibit waivers and disclaimers entirely. Unfortunately, few
statutes actually specify ... whether the waiver must take any particular form." Lefcoe,
supra note 84, at 235-36 (footnotes omitted).
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thereby shifting the burden of inspection to the
of nondisclosure,
93
buyer.
These two statutory remedies, mandatory disclosure pursuant to statutory
mandates and disclosure of no or limited information as it pertains to
nonlatent defects and the quality of the premises conveyed, seem to be
polar opposites, embracing disparate policy objectives. It seems rather
odd to state as a matter of public policy that the seller must disclose
pursuant to a statutory form to provide requisite information to the seller
or, if the parties agree, in the same jurisdiction the seller can, by using
another form, disclose no information. The latter seems to undercut the
former and would appear to put the seller and buyer at odds or at war
over which form will be used in a state like Virginia or Minnesota in
which the seller has both options.94
On the contrary, both types of statutes serve the same purpose given
the relative bargaining power of the parties and their access to
information. Consistent with economic theory and the original purpose
of the caveat emptor doctrine, these two apparently inapposite rules have
the same goal and effect of equalizing the bargaining power between the
transacting parties and allowing for the efficient transfer of information
regarding the quality of the property by and between the parties in these
arms-length transactions. An economic analysis of caveat emptor light
reveals that each rule is efficiency maximizing, providing appropriate
incentives to the buyer and seller in a complex transaction that has
Scholars are divided on whether sellers should be able to waive their common93.
law right to seller disclosure. Some scholars contend that sellers should be
able to waive this right. They see no good reason to deny enforcement of a
contract between a risk-averse seller and a risk-seeking buyer-the very model
of an economically efficient transaction....
A good case can be made against allowing waivers and disclaimers of
seller disclosures. Rational risk allocation starts with a rational risk assessment.
Even the best home inspector is likely to overlook some defects unless the
seller reveals them or points the inspector in the right direction. No buyer can
sensibly waive the seller's disclosure until the buyer learns what the seller is
trying not to disclose.
Id. at 236-37.
94. See, e.g., MINN. STAT. ANN. §§ 513.51-59 (West 2007) (requiring the seller to
disclose material facts regarding the condition of the premises). Section 513.60
provides, however, that "[t]he written disclosure required under sections 513.52 to
513.60 may be waived if the seller and the prospective buyer agree in writing." Id.
§ 513.60; see also VA. CODE ANN. §§ 55-517 to -525 (2007) (stating similar provisions).
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evolved over the five centuries since the common law doctrine was
articulated. 95
III. CAVEAT EMPTOR LIGHT-AN ECONOMIC ANALYSIS
The common law doctrine of caveat emptor is predicated on two
fundamental assumptions: the first assumption is that the premises being
conveyed are simple and easy to inspect, while the second is that each
party to the transaction has equal access to information regarding the
quality of the premises conveyed. The second premise or assumption
follows logically from the first. What is interesting to note is that at the
time the doctrine of caveat emptor developed, the fact that the seller
owned the property for a period of time was irrelevant in terms of what I
characterize as the "equal access principle" with respect to the conveyed
property. It was assumed at common law that the seller did not possess
information that was not accessible to the buyer following the buyer's
visible inspection of the premises, regardless of how long the seller
owned the property.
At the time the doctrine developed, this was a factually accurate
assumption. Without the mechanical, complex plumbing, heating, air,
and ventilation systems that are integral to a modem dwelling-along
with other factors today such as a nontoxic, non-mold, non-radon, et
cetera environment-the property being conveyed at common law
consisted typically of four walls, a dirt floor, and a rudimentary, typically
thatched, roof.96 The kitchen, if you could call it that" consisted of a
stone hearth in the middle of the room.97 There was, of course, no indoor
plumbing and nothing akin to a modem bathroom. There were rarely
windows and the door was, well, a wooden door. 98 Hence, inspecting
the premises for defects was a relatively easy task for the buyer. Indeed,
given the condition of the housing or dwelling to be conveyed, it is hard
to imagine what could be viewed as a defective dwelling. 99 Nevertheless,
what information there was to be gleaned about the condition of the
premises could easily be accomplished by a visual inspection of the
premises.
95. See supra Part II.B.
96. See Leamer.org, The Middle Ages-More About Homes, http://www.learner.org/
exhibits/middleages/morehome.html (last visited Mar. 20, 2008).
97. Id.
98. Id.
99. I assume that if the walls were rotted or the roof failed to keep water out, those
things were discoverable upon visually inspecting the premises. Beyond that, I am not
sure what a buyer would look for to determine that the premises were defective and
uninhabitable.
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The bottom line at common law is that the owner-seller's use and
occupation of the premises, no matter how long, gave that seller no
advantage or extra insight or information with respect to the soon to be
conveyed premises. Thus, consistent with the economic theories of
Kronman, Cooter and Ulen, and Scheppele, there should be no duty to
disclose information from seller to buyer with respect to conveyed
property. 00 Ergo, the common law doctrine of caveat emptor-no duty
to disclose and the seller's privilege to remain silent.
Fast forward to the last forty years as the doctrine of caveat emptor
has been eroded. The modem dwelling bears little resemblance to the
dwelling conveyed in the Middle Ages. Suffice it to say, the modem
dwelling, replete with modem plumbing, heating, ventilation and air
conditioning systems, complex lighting and electrical systems, powered
by gas, electricity with heat pumps, and furnaces, built with composite
and nonnatural materials, four to five times the size of the Middle Age
dwellings, costing hundreds of thousands of dollars,' 0' cannot be compared
to the dwelling conveyed in the Middle Ages.
Not only has the complexity of the dwelling changed, just as
importantly, the level of complexity of the dwelling or structure is
magnified and exacerbated by the fact that dwellings are themselves
largely unique and nonfungible. 0 2 Whereas the dwelling conveyed in
the Middle Ages was largely indistinguishable from other dwellings
being built and sold at the same time-in large part due to the
rudimentary nature of the structure-today's modem dwelling is anything
but uniform and typical. Quite the contrary, most homeowners and
builders seek and prize individuality and uniqueness and the more
unique a dwelling, the more valuable it may be as a result.
100.
See supra notes 1-8 and accompanying text.
101.
According to the U.S. Census Bureau, the median sale price of new one-family
houses in the United States was $240,900 in 2005. U.S. CENSUS BUREAU, STATISTICAL
ABSTRACT OF THE UNITED STATES: 2007, at 603 (2006).
102. It is hornbook law that specific performance will be granted with respect to
real estate contracts because the subject of the contract, real property, is by definition
unique. See, e.g., Anthony T. Kronman, Specific Performance, 45 U. CHI. L. REv. 351,
355 (1978). At common law, the land made the contract unique, justifying the remedy of
specific performance. Today it could be argued that the dwelling that sits on the land
and its uniqueness are what justify the remedy of specific performance. See JOHNSON,
supra note 9, § 5.04(A). But see Centex Homes Corp. v. Boag, 320 A.2d 194, 198-99
(N.J. Super. Ct. Ch. Div. 1974) (refusing to allow specific performance where the object
of the suit was one of 3600 condominium apartments which were held to be nonunique
and fungible).
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I contend that a comparison of one hundred dwellings in a community
chosen at random would reveal one hundred different homes when
measured by size, design, features, complexity, et cetera. That uniqueness
increases, and in some cases makes impossible, the search cost for the
average buyer purchasing property. The idiopathic nature of the dwelling
being sold precludes the buyer from becoming an expert ex ante with
respect to the dwelling being purchased. The buyer cannot school
herself on what to look for when purchasing a home because the buyer
cannot determine the type of home, and its various features, that the
buyer will ultimately purchase. Further, given the complexity of the
dwelling conveyed, even if the buyer could identify ex ante the type and
features of the dwelling conveyed, the effort it would take to educate the
buyer in order to qualify the
03 buyer to make a meaningful inspection
prohibitive.'
is
and
be
would
Just as importantly, the status of seller and buyer has changed radically
as well. The common law doctrine of caveat emptor presupposes that the
parties have equal bargaining power with respect to the condition of the
premises and that each can independently verify the condition of the
premises. That supposition, accurate with the jack-of-all-trades vendor
and vendee at common law, is totally inaccurate with respect to the skills
and knowledge of the seller and buyer today, which is not to say that the
seller is more skilled than the buyer in assessing the condition of the
premises or detecting defects. Neither party is skilled at assessing the
quality of the premises; so to that extent, there is equality of bargaining
power. However, that equality changes given the seller's occupation of
the premises and the knowledge of the condition of the premises
acquired as a result.
Putting these three factors together-the complexity of the dwelling,
the uniqueness of dwellings being conveyed, and the lack of skills
possessed by the buyer, and to a lesser extent, by the seller-results in a
transaction that is radically different from the transaction of a dwelling
in the Middle Ages. The continued imposition of a doctrine, caveat
emptor, on a transaction in which the parties possessed asymmetrical
information about the property conveyed caused the erosion of the
doctrine as detailed above. 104 The cases finding liability for nondisclosure
are a logical outgrowth of the change in bargaining power and knowledge
103.
The increase in the use of a professional home inspector for the sale of
residential realty is a natural byproduct of the increased complexity of the dwelling.
However, as discussed supra at note 43 and accompanying text, even hiring a
professional inspector to inspect a home prior to the sale does not result in the
equalization of bargaining power and the playing field between buyer and seller with
respect to information regarding the condition of the premises.
104. See supra Part II.B.
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possessed by seller and buyer with respect to the condition of the
premises and are 0 easily
explainable pursuant to the economic theories
5
dealt with above.
A. The Development of Mandatory DisclosureRules:
The New Safe Harbor
The passive nondisclosure cases which are premised on the seller's
superior knowledge of the dwelling as a result of the seller's habitation
of the dwelling is consistent with all three theories because the
information possessed by the seller is casually acquired, redistributive,
and accessible to the seller as opposed to the buyer. Hence, it makes perfect
sense that caveat emptor would be jettisoned in favor of a disclosure
rule. What is interesting are the two inapposite default rules that have
developed as exceptions to the common law doctrine of caveat emptor.
At first glance, the safe harbor of mandatory disclosure of a prescribed
laundry list of items alongside a safe harbor of no disclosureessentially a return to the common law doctrine of caveat emptorwould seem counter factual and self-defeating. However, given the
relationship between seller and buyer, the fact that the determination of a
breach of duty of disclosure is made with judicial hindsight, and the
preexistence of the common law rule as a default rule between buyer and
seller, have combined to produce these two seemingly disparate safe
harbor outcomes.
Perhaps the most important fact leading to mandatory disclosure
statutes is the fact that decisions breaching the common law rule of
caveat emptor are made after the sale has occurred. It may take a while
to connect this, but the problem with the erosion of the caveat emptor
doctrine is that one cannot predict ex ante which information must be
disclosed to the buyer by the seller. Even with respect to casually
acquired information that is redistributive and accessible to one party to
the transaction, the problem is determining which of these casually
acquired facts must be disclosed to the buyer ex ante. What has heretofore
gone unnoticed and unrecognized is that the seller's relationship to the
land is akin to what has, in another context, been characterized as a
relational contract.' 0 6 That may seem to be an odd claim, but it is one
105.
See supra Part I.B.
106.
A relational contract is defined as follows:
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that may explain why the erosion of caveat emptor has occurred in the
manner described.
It is beyond doubt that the knowledge of the premises acquired by an
owner of property is casually acquired and merely redistributive.
Focusing on access, it is also clear that the seller has greater access to
these facts than the buyer. The real question, however, is which facts
must be disclosed to the buyer given the seller's greater knowledge and
access to the home. A homeowner acquires knowledge of his property
that is both vast and unique. It is vast given the complexity of the
property today and the owner's lengthy occupancy of the premises.' °7 It
is unique because it applies only to the land or property being sold.
Given the permanence of property, the myriad of factors that can affect
value, both objective and subjective, and the degree and volume of the
casually acquired information that is produced and known to the seller,
which is not uniform among sellers as not all sellers living in the same
house for the same period would have the same knowledge of casually
acquired facts, 10 8 how is the determination made regarding which facts
must be disclosed to the buyer?
The answer to that question is impossible to predict without knowing
the knowledge of the seller, the needs of the buyer, and the condition of
the property. The seller's position is akin to that of a relational
contractor because ex ante the seller is unable to reduce the knowledge
A contract is relational to the extent that the parties are incapable of reducing
Such
important terms of the arrangement to well-defined obligations.
definitive obligations may be impractical because of inability to identify uncertain
future conditions or because of inability to characterize complex adaptations
adequately even when the contingencies themselves can be identified in
advance.... [L]ong-term contracts are more likely than short-term agreements to
fit this conceptualization, but temporal extension per se is not the defining
characteristic.
Charles J. Goetz & Robert E. Scott, Principlesof Relational Contracts, 67 VA. L. REV.
1089, 1091 (1981).
107. Although I have not developed a formal formula to express this sentiment, I
think it is fair to state that the longer the owner has owned the property, the more
knowledge she accumulates regarding its condition, quality, defects, et cetera. Indeed,
my thesis is premised on the notion that an owner who has never occupied the
premises-say, someone who has inherited property and is selling it soon after-would
have no or a very limited duty to disclose facts regarding the property given her lack of
familiarity with the premises.
108. This assumes that the skill of the homeowner-seller may impact the data that is
acquired during one's period of occupancy. It seems reasonable to assume that one
seller noticing a few inches of damaged wood may recognize termite infestation-only
because this particular unlucky homeowner previously lived in a house with extensive
termite damage-whereas a neophyte homeowner may not. See, e.g., MICHAEL F.
POT-rER, UNIV. OF Ky. COLL. OF AGRIC., PROTECTING YOUR HOME AGAINST TERMITES,
http://www.ca.uky.edu/entomology/entfacts/entfactpdf/ef605.pdf (last visited Mar. 20,
2008).
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that he has of the premises to a well-defined obligation. Deciding with
certainty or uniformity which facts must be disclosed ex ante is
impractical because of the complexity of the dwelling, the temporal
nature of the relationship--the longer the ownership, the more knowledge
one acquires-and, perhaps most importantly, the contingencies that can
be identified in advance as being relevant. Take for example, the infestation
of termites. As noted, one seller may be aware of a potential termite
infestation given the wood damage that he has seen accumulate over a
period of time. Another seller, an ignorant seller, may not. However,
after the property is sold and the buyer discovers the existence and
extent of the termite infestation, it is inevitable that the seller will be
sued for passive misrepresentation or nondisclosure if the termite
infestation remained undisclosed. The trier of fact will determine that
the reasonable seller would know of the termite infestation and hold the
seller liable, notwithstanding his claim of ignorance.
What is even more frustrating to the seller is that the seller will
disclose all those things that are known or believed to be known or
relevant to the buyer but will not be able to predict ex ante all of those
facts. It stands to reason that if the seller believes the fact to be relevant
to the buyer, the seller will disclose that fact. It is only those facts that
the seller is either unaware of or believes to be trivial and unimportant
that the seller will refuse to disclose. 0 9 And here is the problem or
conundrum: a truthful and honest seller will have in her possession
millions of facts-knowledge-about the house being sold and will have
to determine which ones to disclose to the buyer. Choose wrong, and
the seller exposes himself to liability.
Take, for example, the psychic harm cases. On the one hand, these
cases seem ludicrous because they require the seller to disclose stigmatic
harms to the property. From the seller's perspective, how does she
determine which harms are stigmatic? Noisy neighbors, a skunk under
109.
The objection to this assertion is that a seller will intentionally omit the
disclosure of facts that reflect negatively on the value of the property in order to
consummate the sale of the property. This strategy is irrational and inefficient because,
given the permanency of property and the persistence of defects, this will lead to a
lawsuit that the seller will likely lose. Instead of negotiating a price to reflect the
existence of the defect-transacting over a property rule-the seller would be voluntarily
choosing to exchange this property rule for a liability rule in which a court would ex post
set the damages to be assessed against the seller. Given the uncertainty with respect to
damage awards, it makes much more sense for the seller to accurately and adequately
disclose all defects when there is a rule requiring disclosure of material facts.
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the rear porch, a swastika painted on the wall five years ago, a break-in
and robbery two years ago, a rape that occurred when the home was
occupied by a prior owner, or the fact that the house was a fraternity
twelve years ago? The list goes on and on. On the other hand, when the
buyer, after the sale, presents evidence that any one of these occurrences
is relevant to her and impacts the property's value, the court has to
determine whether that fact should have been disclosed. 10 In some
cases they will find for the buyer, in others for the seller given the
evidence presented.
Furthermore, many of these cases will be correctly decided because
what the courts are attempting to do, with limited success, is to achieve
the correct balance between disclosure and nondisclosure of information
as mandated by the efficiency norms discussed above. Given the losses
that occur as a result of nondisclosure, the lack of accessibility and the
fact that this is indeed casually acquired information, the courts are
correctly imposing disclosure duties on sellers. However these decisions
also create problems for the seller seeking to comply with the new
disclosure regime due to the complexity of the modern dwelling-how
does one determine what is adequate disclosure, especially when that
disclosure requirement is often impacted by the buyer's knowledge and
proposed future use of the premises?
The response on one hand is the formulation of mandatory disclosure
rules that prescribe which conditions must be disclosed by the seller to
the buyer and provide the seller with a safe harbor once there is
compliance. Given the seller's relational ownership of the property, the
knowledge acquired as a result, and the imposition of the duty to
disclose imposed, that duty has to be circumscribed-homogenized, if
you will-by rules limiting the duty to reduce the seller's exposure ex
post. This mandatory disclosure also serves a related function in the
identification and communication of those common facts regarding the
condition of the premises that should or are relevant to most or all sellers
and buyers. It thereby eliminates from the disclosure requirement
idiopathic facts that are important to the buyer, and perhaps known to
the seller, and impact value. As a result, it places the burden on the
buyer who is interested in either the verification or elimination of the
idiopathic fact that is relevant to that buyer to verify the existence of that
fact or verify its elimination or nonoccurrence with respect to the
property conveyed. The new mandatory disclosure rules, therefore, shift
the burden to the buyer to elicit information regarding the condition of
110. Once again, it should be self-evident that if the seller had any inkling that the
fact would be the subject of a later lawsuit, the seller would have disclosed the fact to the
buyer. See supra note 109.
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the premises once the baseline determination mandated by the statute is
made from seller to buyer.
B. The Reemergence of Silence, The Return of Caveat Emptor
At the other end of the spectrum is the reemergence of the common
law doctrine of caveat emptor, but not as an uncommunicated default
rule that the parties ostensibly bargain in light of and with full
knowledge. Recall that at common law the prevailing rule was silence,
and it was assumed by all, both buyer and seller, that caveat emptor was
the norm and that if the seller opted out of the norm, by making a
representation regarding the quality of the property, that representation
had to be accurate and truthful."' The reemergence of caveat emptor in
those states that allow the seller to remain silent is not premised on both
the buyer and seller having knowledge that the caveat
emptor rule is the
2
standard default rle in the sale of real property."
Quite the contrary, caveat emptor, or seller's silence, can only be
deployed in these states if that doctrine is essentially chosen by the seller
and communicated expressly to the buyer. The default, or off-the-rack
rule, that the parties bargain in light of, is disclosure, but in these states
the parties may opt out of the default rule by choosing caveat emptor.
Consequently, to some extent, the law has come full circle in this area in
those states where the seller is privileged to make no disclosure to the
buyer as long as that fact is clearly communicated to the buyer prior to
the consummation of the sale.
Has this return to an express caveat emptor accomplished anything?
Yes, I believe so, and the key, once again, is to focus on the parties'
knowledge of the property and access to information. At common law
where the default rule was caveat emptor, the law presumed the parties
were aware of the default rule because of the equal access and equal
bargaining power that the parties possessed. The modem buyer and
seller, however, do not have that equal access to information, nor the
equal bargaining power possessed by their historic predecessors. In the
modem setting, the imposition of a default rule of caveat emptor puts the
buyer at a serious disadvantage unless the buyer is made aware of the
fact that she has a duty to undertake an investigation of the property
because the property is indeed being sold as is. In other words, the
111.
112.
See supra notes 55-62 and accompanying text.
See supra notes 96-100 and accompanying text.
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common law default rule is not aligned with the parties' reasonable
expectations in the modem transaction. The new default rule, which
requires the seller to put the buyer on notice with respect to his
disadvantaged position in terms of access to information regarding
quality of the premises, corrects this lacuna.
The common law caveat emptor doctrine is also premised on the
supposition that the putative buyer may casually acquire information
regarding the quality of the premises based on the buyer's self-inspection of
the premises. As pointed out above, today's buyer is ill-equipped to
undertake a meaningful and quality inspection of the premises, and the
seller's notification to the buyer that the property is being sold as is
serves as notification to the buyer to obtain such an inspection or
purchase or "let the buyer beware, who ought not be ignorant of the
amount and the nature of the interest he is about to buy, exercise
caution."' 13
This new safe harbor for nondisclosure differs from the common law
because it assumes that there is no equal bargaining power or equal
access between buyer and seller-the seller may have access to
information that is casually acquired, but that information cannot be
casually acquired by the buyer-but nevertheless places the burden on
the seller to notify the buyer that there is potentially valuable information
regarding the quality of the property that may be acquired by the buyer
by undertaking a thorough and meaningful investigation. In effect, the
default rule has changed to alert the buyer and align with the parties'
expectations with respect to the parties' duties for information seeking or
gathering.
Hence, there have been two shifts in the law of caveat emptor in
response to the change in the character of the property and the
diminution of the assessment skills of the seller and buyer. First, given
the myriad of details that are learned about the property by the seller
given the seller's occupancy and its possible relevance to the buyer, the
law now provides a safe harbor by dictating what must be disclosed.
What seems to be the converse is the development of the doctrine that
permits the seller to make no disclosure. This rule is premised on the
notion that the buyer can undertake a meaningful inspection of the
premises, but only if alerted to do so by the seller.
The first shift in the caveat emptor doctrine-mandatory disclosure
rules-levels the playing field and puts the parties back into the same
position they were in before the erosion of caveat emptor. By that I
mean that the first shift guarantees equal access to information and equal
113.
Pomeranz, supra note 51; see also supra notes 106-08 and accompanying text.
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bargaining power by prescribing which information must be disclosed.
It therefore prevents opportunistic behavior on the part of the seller, but
also assures a baseline state of information for the buyer and provides a
starting point to the acquisition of additional information. The second
shift in the caveat emptor doctrine, nondisclosure, accomplishes the same
result, equality of access and bargaining power, by expressly shifting to
the buyer the duty to deliberately acquire information. In effect, this
second rule presupposes that once no casually acquired information is
communicated from seller to buyer, the buyer will make deliberate
information since it may not be
investment in acquiring the requisite
4
casually acquired from the seller. 1
What the seller cannot do in those jurisdictions which have adopted
one or both of these two new rules, mandatory disclosure or no
disclosure, is telling and informative. The seller cannot choose which
facts to disclose and rely on the truth of those statements to serve as a
safe harbor from liability. It is the selectivity of the disclosure that
creates issues because it may assure the buyer that other facts either are
unimportant or not necessary to be disclosed. The selectivity of the
others-can easily lead to liability for
disclosure-some facts and not
5
innocent misrepresentation." 1
IV. FROM CRYSTALS TO MUD TO CRYSTALS: THE IMPACT OF
TECHNOLOGY AND CHANGE
Professor Rose's oft-cited article, Crystals and Mud in PropertyLaw,
elegantly presents a theory about how crystal rules in property-hard-edged rules that are definitive and easy to apply and manage-are
often replaced by what she characterizes as "fuzzy, ambiguous rules of
decision," or mud rules. 1 6 Crystal rules are said to emerge when goods
or resources become scarce and parties must trade and bargain over
these valuable entitlements. The puzzle, as articulated by Professor
Rose, is why then are mud rules substituted for crystal rules, especially
114.
Although this seems contrary to the efficient theory of disclosure of information,
requiring the buyer to make an investment in acquiring information that could be easily
conveyed to the buyer by the seller, the fallacy of that statement or position is that the
seller cannot determine ex ante which facts must be conveyed. See supra notes 109-10
and accompanying text.
115. See supra notes 77-78 and accompanying text.
116. Rose, supra note 11, at 577-78.
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when these crystal rules, once muddied, are replaced
by crystal rules,
117
which are then subjected to being muddied anew?
One prime example, 1 8 cited by Professor Rose, of this modificationcrystallization cycle is the common law doctrine of caveat emptor,
which she states began as a crystal rule-let the buyer beware-but has
evolved into a mud rule, given the myriad exceptions to the common law
rule for which the seller can be held liable for failure to disclose
defects. 19
For several hundred years, and right up to the last few decades, caveat emptor
was the staple fare of the law of real estate purchases, at least for buildings
already constructed. The purchaser was deemed perfectly capable of inspecting
the property and deciding for himself whether he wanted it, and if anyone were
foolish enough to buy a pig in a poke, he deserved what he got. Short of
outright fraud that would mislead the buyer, the seller had no duties to disclose
anything at all.
One chink in this otherwise smooth wall was the doctrine of "latent defects,"
which, like the exception for fraud, suggested that perhaps the buyer really can't
figure things out entirely....
Within the last few decades, the movement to mud in this area has become
even more pronounced as some courts and legal commentators
maintain that
20
builder/vendors implicitly warrant a new house "habitable."I
117. Quite aside from the wealth transfer that may accompany a change in the rules,
then, the change [from crystal to mud rules] may sharply alter the clarity of the
relationship between the parties. But a move to the uncertainty of mud seems
disruptive to the very practice of a private property/contractual exchange
society. Thus, it is hardly surprising that we individually and collectively
attempt to clear up the mud with new crystal rules-as when private parties
contract out of ambiguous warranties, or when legislatures pass new versions
of crystalline record systems-only to be overruled later, when courts once
again reinstate mud in a different form.
These odd permutations on the scarcity story must give us pause. Why
should we shift back and forth instead of opting for crystal when we have
greater scarcity [of resources]? Is there some advantage to mud rules that the
courts are paying attention to? And if so, why do we not opt for mud rules
instead?
Id. at 579-80 (footnotes omitted).
118. Id. at 580-83. Other doctrines that have allegedly gone through a similar
process are: (1) mortgage foreclosures, which were once strictly enforced when there
was a default on the mortgage-an objective fact-to the current state of affairs in which
the mortgagor is given the right of the "equity of redemption" in certain situations that
cannot ordinarily be conveyed to the mortgagee by the mortgagor ex ante; and (2)
recording acts, which evolved from strict
"race" statutes in which the first to record-an
objective fact-prevailed over those subsequent into "notice" and "race-notice"
recording acts that precluded the first to record from prevailing if that prior recorder had
"notice" of another's interest in the property. Id. at 583-90.
119. For more on the exceptions, see supra notes 63-65 and accompanying text.
120. Rose, supra note 11, at 580-81 (footnotes omitted).
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Moreover, what I have characterized as the reemergence of caveat
emptor in the guise of caveat emptor light, 12 1 Professor Rose characterizes,
in part, as the reemergence of a crystal rule:
But there is a countermove as well: Even if the legal rules have moved
toward mud, private bargainers often try to install their own little crystalline
systems through contractual waivers of warranties or disclosure duties (for
example, the "as is" or "no warranty" sale). These private efforts in effect move
things into the pattern of a circle, from crystal to mud and back to crystal. And
the circle turns once again when the courts ban such waivers, as they sometimes
do, and firmly 22
re-establish a rule of mud-only to be followed by even more
artful waivers. 1
In her brief essay, Professor Rose speculates that the crystal rules,
which are more efficient rules and therefore favored by academics,
become mud rules because of their overuse and extension to areas for
which they were not originally designed. As a result, these crystal rules
become ill-suited to police and regulate the transactions they were
promulgated to govem:
But the driving force of the movement to mud rules seems to be an overuse in
the "commons" of the crystal rules themselves: We are tempted to take rules
that are simple and informative in one context-as, for example, "first in time,
first in right" may be in a small community-and extend them to different or
more complex situations, where the consequences may be unexpected and
confusing. It1 is
in these "overload" situations that crystal rules may ultimately
23
impede trade.
Another factor contributing to mud rather than crystal rules pertains to
the relationship between the contracting parties.
Professor Rose's
theory, supported by existing economic literature, is that we are more
likely to find crystal rules employed when the contracting parties are
engaged in a one-shot, contingent contracting relationship rather than a
relational contract.124 Mud rules are used in the relational context
because they allegedly provide the flexibility necessary for the parties to
make adjustments as their relationship develops and matures.
But what is easily overlooked is that mud rules, too, attempt to recreate an
underlying non-legal trading community in which confidence is possible. In
those communities, the members tend to readjust for future complications, rather
than drive hard bargains. Mud rules mimic a pattern of post hoc readjustments that
people would make if they were in an ongoing relationship with each other....
121.
122.
123.
124.
See supra notes 84-95 and accompanying text.
Rose, supra note 11, at 582-83 (footnotes omitted).
Id. at 600 (footnotes omitted).
See supra notes 11-13 and accompanying text.
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Now we can see why crystal and mud are a matched pair. Both are distilled
from a kind of non-legal commercial context where people already in some
relationship arrive at more or less imperfect understandings at the outset and
expect post hoc readjustments when circumstances require. Just as the parties
call on courts to enforce promises and protect entitlements that would otherwise
be enforced by the threat of informal sanctions, so too do they call on the courts
to figure out the post hoc125
readjustments that would otherwise have been made
by the parties themselves.
The final piece of the puzzle, according to Professor Rose, is the
tendency of the judiciary to impose mud rules in resolving disputes that
it adjudicates due to the ex post nature of adjudication. 26 To sum up:
Here, then, the circular pattern emerges: If things matter to us, we try to place
clear bounds around them when we make up rules for our dealings with
strangers so that we can invest in the things or trade them. The overloading of
clear systems, however, may lead to forfeitures--dramatic losses that we can
only see post hoc, and whose post hoc avoidance makes us (as judges) muddy
the boundaries we have drawn. Then, at some point we may become so stymied
by muddiness that as rulemakers we 127will start over with new boundaries,
followed by new muddiness, and so on.
Caveat emptor, then, represents the epitome of a rule that evolves
from crystal to mud and thence to crystal. First, crystal rules are
extended--overused-to situations that are inapposite leading to
inefficient and unjust outcomes. Caveat emptor, in its pristine common
law form, applied to a very simple structure in which all defects were
essentially immediately visible. 28 Furthermore, the seller, by residing in
the dwelling, gained no particular unique knowledge of the premises as a
result. Hence, the parties to the common law transaction possessed equal
bargaining power and equal knowledge with respect to the quality of the
building. Subsequently, as a result of the increasing complexity of the
dwelling, these positions changed, although the doctrine did not. Sellers
became more knowledgeable about defects in the premises that were not
easily discoverable by the buyer. As a result, when the buyer found
himself fleeced, now in the role of the mope, to use Professor Rose's
125. Rose, supra note 11, at 602-03.
126. [J]udges, who see everything ex post, really cannot help but be influenced
by their ex post perspectives. They lean ever so slightly to mud, in order to
save the fools from forfeiture at the hands of scoundrels. Indeed, if judges have
even an occasional preference for post hoc readjustments, to avoid forfeiture,
this preference will gradually place an accretion of mud rules over people's
crystalline arrangements. These considerations suggest a modification of
claims about the efficiency of common law adjudication. We are more likely
to find that judicial solutions veer towards mud rules, while it is legislatures
that are more apt to join with private parties as "rulemakers" with a tilt towards
crystal.
Id. at 603-04 (footnotes omitted).
127. Id. at 604.
128.
See supra note 9 and accompanying text.
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terminology,129 courts were more willing to muddy the crystal rule to
provide exceptions in order to grant the buyer relief from her necessitous
circumstances.
Second, although the contract is not relational, the requirement that
information not be conveyed, as allowed by caveat emptor, is once again
inapposite in a situation where the seller acquires information in a
relational context and is privileged not to convey same in the context of
the contingent contract entered into with the buyer. That inequality of
bargaining power-relational knowledge in a contingent contract settingleads to scoundrels fleecing, sometimes inadvertently, sometimes not,
the foolish (mope) buyers who fail to adequately protect themselves by
undertaking an adequate inspection and the acquisition of the necessary
information regarding the quality of the premises. Just as predicted by
Professor Rose, courts in these settings were moved to make post hoc
readjustments that led to the erosion of the doctrine and resulted in the
imposition of a mud rule.
But in addition to the three factors that Professor Rose has identified
to explicate why crystals turn to mud and thence crystals, an examination of
caveat emptor reveals two heretofore additional reasons why these rules
change and become muddied. Professor Rose's theory is incomplete in
one respect because she does not take into account how the property or
resource that is the subject of the crystal rule might also evolve to
become inapposite to the crystal rule. 130 In other words, these are not
static rules or doctrines affecting static and unchanging properties.
129. The seller in this setting plays the role of the scoundrel. Rose, supra note 11,
at 599-600.
130. Indeed, technological changes in the property might also be a proximate cause
of the shift from crystal to mud rules. For example, the evolution of the law of caveat
emptor via decisional law may reflect the fact that the housing that is subject to the rule
is different and distinct from the type and quality of housing that initially produced the
rule. That evolution in the law and its resultant impact on subsequent property
transactions might then cause the law to continue to evolve so that a mud rule-created
largely by the change in the nature of the premises-may eventually become a crystal
rule through decisional authority as the law continually deals with the technological
enhanced premises. For example, take the sale of residential real estate. Although we
are currently in a cycle in which mud rules apply to the sale of real property, as opposed
to the crystal rule embodied in the common law doctrine of caveat emptor, I predict that
a crystal rule will emerge eventually. I contend that sellers will adapt to the muddy rules
by embracing norms that will result in the standardization of implied warranties--default
rules-given by the seller to the buyer in the sale of the premises. If that state is
achieved, through norms or legislation, then a crystal rule may once again be imposed on
the residential real estate transaction.
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Quite the contrary, as technology evolves and changes, ill-fitting rules
must also evolve and change to address those changes.
In other words just like the law is not static, neither is the object or
subject of the rule being analyzed. What works initially for a crystal rule
may not work for something that is called the same thing but has
technologically evolved far beyond its original form or design. It should
be self-evident that the caveat emptor doctrine worked as a default rule
at common law due to the simplicity of the dwelling it was designed to
regulate or govern. As the dwelling became more complex, morphing
into something that is nothing like the agrarian dwelling to which the
original rule applied, the courts were unable to declare the old rule
obsolete and develop a new rule given how common law rules evolve
via court decisions instead of legislative fiat and declaration. As the
property evolved slowly and inexorably to its current form, the doctrine
of caveat emptor also evolved to take into account the different
characteristics of the property regulated.
This evolution of the property being regulated represents a different
challenge than, say, the creation of a new property right like the
Internet. 131 The development of a new form of property also creates the
recognition and awareness that there is a void in the existing regulatory
structure to govern the new entity. Scholars and judges jump into the
fray to fill the void created when the new property is created. With
respect to existing and evolving property, no void exists. Instead judges
and legislators must modify the crystal rules, making them mud, in order
to regulate the newly evolved species of property. The insight that is
missing from Professor Rose's theory regarding how mud rules become
crystal is the lack of analysis and recognition of the evolution of the
property that is being regulated by the rules. That evolution of the
property should also force an evolution in the norms, mores, et cetera,
and in the rules governing the property rights.
The second insight gained by an analysis of caveat emptor and its
evolution into caveat emptor light is the fact that crystal rules are more
likely to be used for what I designate "objective" determinations, and
mud rules are more likely to be used for "subjective" determinations
where multiple variants play into the equation concerning how resources
or rights should be allocated. Put another way, as determinations
become more subjective with more variables being considered by the
courts, the muddier the rules become. 32 An analysis of the three fact
131.
See, e.g., David R. Johnson & David Post, Law and Borders-The Rise of Law
in Cyberspace, 48 STAN. L. REV. 1367 (1996).
132. Here I may be stating the obvious or restating what Professor Rose has
characterized as the "overuse" of the doctrine in situations not particularly suitable for
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situations described by Professor Rose in her article as prototypical
crystal rules involves objective determinations. 133 Thus the fact that the
seller has no duty to disclose (caveat emptor); the mortgagor did not
make the payment on law date (the equity of redemption); and the losing
party was not the first to record (the operation of recording acts) entails a
determination made by the trier of fact that is bipolar-yes or no-not
maybe or partially, but definitive and dispositive. Crystal rules, thus,
work best when the fact to be decided is either up-down or yes-no with
no subtle gradations to be made.
Think of it this way: the common law sale of a house was a crystal
transaction-objective and verifiable-something akin to a contingent
one-shot transaction in which the parties were not repeat players. In
fact, many have alleged that the residential real estate transaction is the
epitome of a contingent contract that should lead to the use of crystal
rules. 134 However, I contend that today's transaction is more subjective
and akin to a relational contract. In order to determine the enforceability
of the transaction, the court must determine what this seller knows and
what is important to this buyer. It is individualized and subjectivized to
an extent that was not relevant at common law. Hence, importantly,
even though the parties in a real estate contract represent prototypical
contingent contracting parties, the nature of the information sought is in
fact relational. Underlying the theory of relational versus contingent
contracts is the notion that in contingent contracts the parties are dealing
at arms length and each can take the maximum steps to protect their
respective positions. That is not true in the sale of the residence and has
caused the further erosion of the doctrine of caveat emptor.
Consequently, adding these two elements to Professor Rose's theory
makes its explanatory power more robust. I would expect to see crystal
rules become mud rules not only when: (1) crystal rules are extended to
nonobvious situations; (2) when parties are in a relational contract; and
(3) when courts are called to make an ex post adjudication that will
involve the forfeiture of a significant asset; but also (4) in situations
the extension of the doctrine. See supra notes 122-23 and accompanying text. However, I
think it is important to note, if only as a descriptive matter, that when courts are called
upon to look at fact situations that I have described as objective, they tend to adopt mud
rather than crystal rules given the complexity of the fact situations and the variables
involved.
133. Rose, supra note 11, at 580-90.
134. See supra note 124 and accompanying text.
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where the variable being decided is subjectivized; and (5) the asset or
variable about which the decision is made is itself evolving into a
significantly different asset due to technological advances. When all
five of these variables are aligned, crystal rules will inevitably become
mud rules and lead to the development of crystal rules to replace the
muddied rules.
V. CONCLUSION
This Article represents an attempt to wed two seemingly disparate
theories to explain why the common law doctrine of caveat emptor has
evolved as it has over the last five centuries. Taking first Dean
Kronman's theory of the efficient disclosure of information, I have
addressed a puzzle that has remained unresolved: why did the caveat
emptor doctrine develop when the seller clearly has knowledge about the
premises that should be disclosed pursuant to those apparently accurate
efficient disclosure theories? By undertaking a historical analysis I have
demonstrated why the common law rule of caveat emptor initially
developed, why its erosion has been accomplished, and why it is
currently reemerging pursuant to a doctrine I have designated as caveat
emptor light.
Concurrently I have taken Professor Rose's elegant theory regarding
the evolution of rules from crystal to mud and thence back to crystal and
applied it to the caveat emptor doctrine. In so doing, I demonstrate first
that the caveat emptor doctrine represents the perfect doctrinal theory to
prove her thesis. Perhaps more importantly, I have also attempted to
demonstrate that Professor Rose's analysis is somewhat incomplete and
must take into account the relationship of the parties and the evolving
character of the resource being regulated in order to be complete. An
analysis of the caveat emptor doctrine and its evolution confirms that
mud rules will be applied when objective situations become, over time,
dependent on subjective determinations given the status of the parties.
These subjective determinations are exacerbated by the technological
evolution of the property being regulated. Just as law evolves, so, too,
does the property subject to its strictures. As property evolves, so, too,
must the law that governs and regulates its ownership and use.
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